Break up banks

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See also Glass Steagall, leverage, liquidity, narrow banks, resolution authority, and too big to fail.


S. 3241 SAFE Banking Act of 2010 defeated

Accordingly, Senators Brown and Kaufman have introduced legislation that would impose sensible size and leverage constraints:

Size Limits on Our Largest Financial Institutions

  • Imposes a strict 10% cap on any bank holding company's or thrift holding company's share of the total amount of deposits of insured depository institutions in the United States.
  • Establishes limits on the liabilities of large banking and nonbanking financial institutions:
  • A limit on the non-deposit liabilities (including off-balance-sheet ones) of a bank holding company or thrift holding company of 2% of GDP.
  • A limit on the overall liabilities (including off-balance-sheet ones) of any non-bank financial institution - i.e. one that the proposed Financial Stability Oversight Council deems a risk to the financial system - regulated by the Federal Reserve of 3% of GDP.

Institute Statutory Leverage Ratio

Codifies a 6% leverage limit for bank holding companies and selected nonbank financial institutions into law.

Brown amendment to cap bank size at 2% of GDP

A group of Senate Democrats introduced a bill on Wednesday that would require the nation’s three largest banks to shrink, in an effort to eliminate the problem of financial institutions being seen as “too big to fail.”

Their proposal, which would put specific ceilings on the size of banks, builds on a provision already in the Senate’s financial regulatory overhaul package that is meant to limit future growth of large Wall Street firms.

“The major issue is to keep the banks from getting too large to begin with,” the lead sponsor of the bill, Senator Sherrod Brown, Democrat of Ohio, said Wednesday morning. “Too big to fail is too big. That’s where we need to be much more aggressive.”

As concern about the risk posed by the biggest financial institutions percolates among populists in Congress and at the Federal Reserve, the lawmakers plan to offer the bill as an amendment to the pending Senate legislation, which could reach the floor as soon as Monday.

The bill would cap the amount of non-deposit liabilities of any one bank — effectively, the amount the bank borrows in various ways to finance its operations — at an amount equal to 2 percent of the nation’s gross domestic product, a measure of the size of the economy. For major financial firms that are not banks, like AIG, Metropolitan Life or the financial arm of General Electric, the cap would by 3 percent of G.D.P.

The bill would reinforce a 1994 law that bars any single bank from holding more than 10 percent of the nation’s total deposits, or about $750 billion. In the years since then, large firms have obtained waivers or used loopholes in the law to exceed that ceiling. Three institutions — Bank of America, Wells Fargo and J.P. Morgan Chase — are over the limit now, and would have to shed the excess within three years.

A number of Republicans have expressed concern about the size issue, and Mr. Brown appeared optimistic Wednesday that his provision could win Republican support.

“I would challenge any Republican to co-sponsor this issue,” he said. “If they are really concerned about ‘too big to fail,’ they should want to keep them from getting that big in the first place.”

Senator Ted Kaufman, Democrat of Delaware, who is a co-sponsor of the bill, said that the Federal Reserve has had the power to limit the size of banks since 1970, but has not acted. Instead, the nation’s six largest bank holding companies — Citigroup, Goldman Sachs and Morgan Stanley are the other three — have only grown bigger over the last year and a half, mainly as a result of government-brokered mergers. They can now borrow at significantly lower rates than their smaller competitors, a result of the bond market’s implicit assumption that the government will never allow them to fail.

Treasury Department and Federal Reserve officials have rejected calls to break up the biggest financial institutions, saying bank size alone is not the most important threat.

Congressional momentum developing to break up banks

"...In the sweeping legislation before the Senate, there is no attempt to break up big banks as a means of creating a less risky financial system. Treasury Department and Federal Reserve officials have rejected calls for doing so, saying bank size alone is not the most important threat.

Instead, the bill directs regulators to compel the largest banks to hold more capital as a cushion against losses. It sets up a procedure intended to allow big banks to fail, with the cost borne not by taxpayers but by the biggest financial institutions.

As the debate over the regulatory overhaul heated up this week, a populist minority in both Congress and the Fed requested a revisit to the size issue. They would like to go beyond a provision in the bill, suggested by Paul A. Volcker, the former Fed chairman, and supported by President Obama, that would seek to keep banks from growing any larger but not force any to shrink.

“By splitting up these megabanks, we by definition will make them smaller, safer and more manageable,” Senator Edward E. Kaufman Jr., Democrat of Delaware, said in a speech Tuesday.

The president of the Federal Reserve Bank of Dallas, Richard W. Fisher, broke ranks with most of his colleagues within the central bank last week, declaring, “The disagreeable but sound thing to do regarding institutions that are too big to fail is to dismantle them over time into institutions that can be prudently managed and regulated across borders.”

There also has been concern about the size of banks from Republicans who believe in free-market principles. Several senators from the South and West — Richard C. Shelby of Alabama, Johnny Isakson of Georgia, John Cornyn of Texas and John McCain of Arizona — have expressed a desire to revisit the 1999 repeal of the Glass-Steagall Act, the Depression-era law that separated commercial and investment banking.

Alan Greenspan, the former Fed chairman, has entertained the idea of splitting up the banks but has stopped short of advocating it.

“If they’re too big to fail, they’re too big,” he said in an October speech.

He added: “In 1911, we broke up Standard Oil. So what happened? The individual parts became more valuable than the whole. Maybe that’s what we need.”

In January, the White House embraced a proposal by Mr. Volcker that would ban banks that take customer deposits from running their own proprietary trading operations, or making market bets with their own money. It would also limit the share of all financial liabilities that any one institution can hold — besides deposits — but it would be up to regulators to set the limit.

A federal law enacted in 1994 already addresses size by restricting any bank from holding more than 10 percent of the nation’s deposits, although several of the largest banks have been granted waivers from that requirement or used loopholes to evade its intent.

The Volcker proposal resembled an amendment by Representative Paul E. Kanjorski, Democrat of Pennsylvania, that would let regulators dismantle financial companies so large, interconnected or risky that their failure would jeopardize the entire system. The amendment was part of a regulatory overhaul that the House adopted in December, largely along party lines, and is also in the Senate version in a modified form.

At a hearing on Tuesday about the bankruptcy of Lehman Brothers, which caused credit markets to seize up in September 2008, the Fed chairman, Ben S. Bernanke, reiterated that his preference was to limit the risky behavior of banks rather than break them up.

“Through capital, through restrictions in activities, through liquidity requirements, through executive compensation, through a whole variety of mechanisms, it’s important that we limit excessive risk-taking, particularly when the losses are effectively borne by the taxpayer,” Mr. Bernanke said.

But when Mr. Kanjorski pressed him on whether regulators should be allowed to break up big banks, he replied, “It’s something that would be, on the whole, constructive.”

Representative Brad Sherman, Democrat of California, added: “We should go further and not just allow, but require, regulators to break up firms that have reached a certain size.”..."

President Obama announces proposals to limit banking activities

WASHINGTON, DC- President Obama joined Paul Volcker, former chairman of the Federal Reserve; Bill Donaldson, former chairman of the Securities and Exchange Commission; Congressman Barney Frank, House Financial Services Chairman; Senator Chris Dodd, Chairman of the Banking Committee and the President's economic team to call for new restrictions on the size and scope of banks and other financial institutions to rein in excessive risk taking and to protect taxpayers.

The President’s proposal would strengthen the comprehensive financial reform package that is already moving through Congress.

“While the financial system is far stronger today than it was a year one year ago, it is still operating under the exact same rules that led to its near collapse,” said President Barack Obama. “My resolve to reform the system is only strengthened when I see a return to old practices at some of the very firms fighting reform; and when I see record profits at some of the very firms claiming that they cannot lend more to small business, cannot keep credit card rates low, and cannot refund taxpayers for the bailout. It is exactly this kind of irresponsibility that makes clear reform is necessary.”

The proposal would:

  1. Limit the Scope - The President and his economic team will work with Congress to ensure that no bank or financial institution that contains a bank will own, invest in or sponsor a hedge fund or a private equity fund, or proprietary trading operations unrelated to serving customers for its own profit.
  2. Limit the Size - The President also announced a new proposal to limit the consolidation of our financial sector. The President’s proposal will place broader limits on the excessive growth of the market share of liabilities at the largest financial firms, to supplement existing caps on the market share of deposits.

In the coming weeks, the President will continue to work closely with Chairman Dodd and others to craft a strong, comprehensive financial reform bill that puts in place common sense rules of the road and robust safeguards for the benefit of consumers, closes loopholes, and ends the mentality of “Too Big to Fail.” Chairman Barney Frank’s financial reform legislation, which passed the House in December, laid the groundwork for this policy by authorizing regulators to restrict or prohibit large firms from engaging in excessively risky activities.

As part of the previously announced reform program, the proposals announced today will help put an end to the risky practices that contributed significantly to the financial crisis.

Wall Street reacts to President Obama's proposal

"An era of high rolling at the Wall Street casino will shortly come to an end if Barack Obama gets his way. The US president has delivered his biggest broadside yet against the financial industry's excesses and is proposing the strictest restrictions on banks' activities for seven decades.

Key to his agenda is a new regulation dubbed the "Volcker rule", the pet project of Paul Volcker, the Federal Reserve boss of the 1980s. Volcker, known as "the tall man" in reference to his 6ft 7in height, is now an economic adviser to the White House. This rule forbids any bank holding deposits guaranteed by the government from operating hedge funds, private equity funds or from trading on its own book.

Alongside this, Obama is proposing an overall limit on the size of any individual bank ? although the White House gave no details of this and it was immediately condemned as a "vague" headling-grabbing aspiration.

The Volcker rule alone will cause havoc at Wall Street's biggest institutions. Unstitching entire parts of their businesses will be seen as far more troublesome than previous political interventions which, in the case of the US, were lacklustre attempts to reduce bonuses and a requirement that banks took temporary treasury loans ? almost all of which have since been paid back.

Such reforms amount to a sudden change of gear for the White House. On taking office a year ago, Obama promised to act tough, blasting bonuses as "the height of irresponsibility" and mooting the possibility of a $500,000 cap on pay at the top echelons of Wall Street. After moderate voices prevailed, including those of his treasury secretary, Timothy Geithner, and the Clinton-era economic guru Larry Summers, the measures were quietly watered down.

The new year, and the annual bonus season that goes with it, has put banks back on the political map and thrown them into heightened controversy, as multimillion-dollar pay packages send Washington into apoplexy.

It emerged recently that one senior executive at Citigroup, John Havens, was being paid $9m, even though the bank was still losing money.

Critics of Wall Street were quick to welcome Obama's renewed aggression. Anna Burger, secretary treasurer of America's SEIU union, said: "President Obama sent a strong and clear message to Wall Street: The game is over. Taxpayers will no longer be held hostage by Wall Street's obsession with reckless policies and obscene profits." But to be enacted, the changes will need to go through Congress which, as the recent battle over healthcare reforms has proved, is no simple matter. "In the form that it's been proposed, I'd be very surprised if it passes," said Gerard Cassidy, a banking analyst at RBC Capital Markets, who foresees huge practical questions.

Among the issues to be settled is whether foreign banks operating in the US will fall under the restrictions. If they do not, then American firms would be able to claim, legitimately, to be suffering a huge disadvantage.

The question of how to cut institutions down to size has been grappled with on the international stage. Since Lehman Brothers collapsed in September 2008, Obama, Gordon Brown, Nicolas Sarkozy and many other world leaders have been debating how to prevent the financial system from crashing down a second time.

In Britain, the most outspoken advocate of reform has been Mervyn King, the governor of the Bank of England. Right from the start, King was exercised by the "moral hazard" implicit in providing multibillion-pound handouts to banks without asking for anything in return.

In public, he weighed up the pros and cons of a reviving America's 1933 Glass-Steagall act splitting investment banks from commercial banks.

King made it clear that he was in favour of moves to restrict the size of banks, saying: "If some banks are thought to be too big to fail then, in the words of a distinguished American economist, they are too big."

Alistair Darling has always taken a cautious approach to City reform, keen to protect London's prominence as a world financial centre. Although the government now wants to diversify the British economy, the chancellor is acutely aware of the fact that the City provides a hefty chunk of the Exchequer's tax revenues.

While good news for investors, this week's clutch of strong profits from JP Morgan, Bank of America, Morgan Stanley and Goldman Sachs have only inflamed public passions ? and in Washington, Democrats view the subject as a sure-fire vote-winner. Stung by Goldman Sachs' handout of $16.2bn in staff remuneration today, Peter Welch, a Democratic congressman from Vermont, accused Wall Street of profiting from the assistance of taxpayers: "There is no question Goldman is good at what it does. The problem is that what it does is not good for the American economy."

Obama proposal may force JPMorgan, Goldman to sell buyout units

"JPMorgan Chase & Co. and Goldman Sachs Group Inc. may have to sell some private-equity businesses and stop investing in buyouts under a proposal by President Barack Obama to limit bets made by banks with their own capital.

Obama asked Congress yesterday to prohibit banks from owning or making investments in private-equity and hedge funds that “are unrelated to serving customers.” While financial institutions could still manage the assets on behalf of clients, they wouldn’t be able to invest in their own funds or those run by firms such as Blackstone Group LP and KKR & Co.

The proposed rules may alter Wall Street’s role in private equity, where banks and investors commit money to buy companies, real estate and other assets. Banks also invest with buyout firms to help deepen their lending relationships.

“In a world where there is less capital available for private equity and hedge funds, this will take out another source of funding,” said Bruce Ettelson, head of the fund- formation group at law firm Kirkland & Ellis LLP in Chicago.

JPMorgan may seek to divest its OneEquity Partners private- equity unit, according to a person familiar with the New York- based bank. OneEquity Partners manages $8 billion in direct investments, with holdings that include TV Guide.

The rules may affect Goldman Sachs’s principal investment group, which includes the New York-based company’s stake in Industrial & Commercial Bank of China Ltd. and real estate. The group reported revenue of $1.17 billion last year.

In addition, Goldman Sachs’s global special situations group makes principal investments within the firm’s fixed-income, currency and commodities business.

Representatives of the banks declined to comment.

No Rush

The government won’t seek to expedite divestitures at banks, House Financial Services Committee Chairman Barney Frank said yesterday.

“It would be a mistake to mandate divestiture of all the hedge funds and private-equity entities that might be covered within a short period of time,” Frank said in an interview. “That would create fire-sale conditions.”

Bank executives said that based on the administration’s comments, they didn’t expect that ownership of hedge funds, such as JPMorgan’s Highbridge Capital Management LLC and Morgan Stanley’s FrontPoint Partners LLC, would fall under the new regulations because these firms manage client assets.

Asset Management OK

Austan Goolsbee, a member of Obama’s Council of Economic Advisers, said in a CNBC interview yesterday that the proposal was “not intended to get rid of asset management as a function.”

JPMorgan’s investment in Highbridge, which has about $23 billion in assets under management, is less than $1 billion.

Obama is seeking to limit the size and trading activities of financial institutions as a way to reduce risk-taking and prevent another financial crisis. In addition to curtailing private-equity and hedge-fund investments, the plan bars banks from running proprietary trading operations solely for their own profit.

Brian Moynihan, chief executive officer of Charlotte, North Carolina-based Bank of America Corp. said last week that isolating proprietary trading could prove challenging for regulators.

“You can try to define it, but I think when you offset a position you are doing it for the firm, you could say that’s proprietary but that’s actually managing a risk,” Moynihan said in testimony before the Financial Crisis Inquiry Commission last week in Washington.

Targeting private-equity investments by banks doesn’t go to the root of the problems that caused the financial meltdown, said Steven Kaplan, a professor at the University of Chicago Booth School of Business.

“Private-equity investments did not cause the crisis,” Kaplan said. “It was their loans that went bad.”

Senator introduces legislation to break up banks

U.S. Senator Bernie Sanders unveiled legislation requiring Treasury Secretary Timothy Geithner to name banks whose collapse may shake the economy and break up the firms in a year, fueling efforts to end taxpayers bailouts.

“If an institution is too big to fail, it is too big to exist,” said Sanders, a Vermont independent. “We should break them up so they are no longer in a position to bring down the entire economy.”

The legislation would give Geithner 90 days to list the commercial and investment banks, hedge funds and insurance companies deemed “too big to fail.” Those firms would be broken up within a year, he said. Representative Paul Kanjorski, a Pennsylvania Democrat, is considering a measure in the House that would break up large financial firms.

Lawmakers seeking to end taxpayer bailouts are considering measures aimed at limiting the size of companies that pose a risk to the financial system. Congress last year set up the $700 billion Troubled Asset Relief Program to shore up Citigroup Inc., Bank of America Corp. and other firms.

“We should end the concentration of ownership that has resulted in just four huge financial institutions holding half the mortgages in America, controlling two-thirds of the credit cards, and amassing 40 percent of all deposits,” Sanders said, citing Bank of America, Citigroup, JPMorgan Chase & Co. and Wells Fargo & Co.

Kanjorski, chairman of a House Financial Services Committee panel on capital markets, this week said he was preparing a measure giving the government power to break apart large firms.

‘Gigantic Tsunamis’

“Nowhere in the world in the future will there be gigantic tsunamis coming out of nowhere and striking the entire world’s economy,” he said on Nov. 4.

The Kanjorski measure would amend Chairman Barney Frank’s draft legislation that creates a regulator council to monitor the economy and firms for systemic risk. The committee today considered proposals to change Frank’s measure, and the chairman has said a final vote by members is scheduled Nov. 20.

“Discussion of breaking up large financial institutions that pose systemic risk to the market is gaining traction on the Hill,” FBR Capital Markets analysts led by Paul Miller said in an investor note Nov. 4. “This legislation is currently in its infancy, and Congress has a number of difficult questions to answer before anything can move forward.”

Federal Reserve Governor Daniel Tarullo said Oct. 21 the idea of breaking up large institutions is impractical, calling it “more a provocative idea than a proposal.” Instead, he said any firm that may pose a risk should be subject to stricter oversight. Former Fed Chairman Alan Greenspan on Oct. 15 said regulators should consider breaking up systemically risky firms.

The New York Times reported the Sanders’ legislation earlier today."

H.R. 4173 Wall Street Reform Act

Improving Financial Stability and Enhancing Prudential Regulation

This legislation --

Creates a Financial Stability Oversight Council to Monitor and Take Actions to Address Systemic Risk:

  • The Council will monitor the marketplace to identify potential threats to the stability of the financial system.
  • Strengthens Regulation and Supervision of Large, Interconnected Financial Firms Reducing the Likelihood of Future Crises:
  • The Council will subject financial companies and activities that pose a threat to financial stability to much stricter standards and regulation, including, with respect to companies, higher capital requirements, leverage limits, and limits on concentrations of risk.

Kanjorski suggests powers for risk council to break up banks

  • Independent Senator Sanders introduces break-up bill
  • Legislation also under consideration in House
  • Sanders would give Treasury 90 days to identify firms

"An independent U.S. senator on Friday introduced a bill that would give the government the power to identify and break up financial firms that are "too big to fail," an idea that is catching on.

"If an institution is too big to fail, it is too big to exist," said Senator Bernie Sanders in a statement.

"We should break them up so they are no longer in a position to bring down the entire economy," he said.

Sanders is an independent outside the U.S. political mainstream. But he is not the only one looking at break-ups.

Representative Paul Kanjorski, the Democratic chairman of the capital markets subcommittee in the U.S. House of Representatives, is working on a break-up power amendment.

It would give a new government systemic risk council break-up power, with clearance from the president.

"It's the natural action of capital to grow and exceed. Now we're going to contain it," Kanjorski told CNBC television.

He said large banks oppose his amendment because it would threaten them. But, he said, mid-sized and smaller financial institutions would be helped by it because they would be better able to compete if mega-firms were downsized.

"When the people's money is being used to bail out these large companies ... We certainly have to have someone to tell them what to do in order to save them," he said.

House Financial Services Committee Chairman Barney Frank said earlier on CNBC that a bill he is working on, which Kanjorski wants to toughen, would let a systemic risk regulator "break up" risky financial firms.

Elsewhere this week, the two largest UK retail banks -- Royal Bank of Scotland (RBS.L) and Lloyds Banking (LLOY.L) -- got more government aid and agreed to sell branches and businesses to appease European Union competition concerns over state aid.

EU regulators are considering measures to force banks across Europe to sell assets and sometimes even to break up to compensate for massive state aid they have received."

US commentators on breaking up the banks

Bernanke supports some downsizing of risky firms

" Federal Reserve Chairman Ben S. Bernanke said regulators should have power to shrink a bank that poses a risk to markets, signaling support for proposals in Congress that let the U.S. cut the size of financial companies.

“The supervisors should be allowed by law to insist that the company divest itself or shrink its activities,” Bernanke said today in response to a question after a speech to the Economic Club of New York.

Regulators could apply the power to a large institution engaged in proprietary trading when they determine that the company can’t manage the risks or doesn’t have enough capital and liquidity to engage in the activity, Bernanke said.

Congress is considering legislation giving government the power to force the breakup of a firm that has become so large that its failure in bankruptcy could threaten the economy. Lawmakers are seeking to avoid ad hoc actions such as last year’s $700 billion bailout of large firms, including New York- based insurer American International Group Inc.

House Financial Services Committee Chairman Barney Frank has proposed giving the Fed power to limit company size by forcing the sale and transfer of assets and off-balance-sheet items. Senate Banking Committee Chairman Christopher Dodd’s plan would give that power to a new systemic-risk regulator that includes the Fed.

Representative Paul Kanjorski, a Pennsylvania Democrat, is planning to amend Frank’s legislation to let regulators dismantle large systemically risk firms. Senator Bernard Sanders, a Vermont independent, unveiled legislation last week requiring the Treasury Department to name banks whose collapse could shake the economy and break them up in a year.

Representative Ed Perlmutter, a Colorado Democrat, wants to amend Frank’s bill so that the Fed could impose the Glass- Steagall Act, which split investment banking from lending and deposit-taking, on a case-by-case basis, an idea Bernanke appeared to reject. The law was repealed in 1999.

“That kind of movement would not be constructive,” Bernanke said."

Fed's Bullard calls for breaking up the banks

A third top Fed official is calling for megabanks to be broken up.

James Bullard, president and chief executive of the Federal Reserve Bank of St. Louis, echoed the call of Kansas City Fed President Thomas M. Hoenig and Dallas Fed President Richard W. Fisher, telling reporters that the nation's biggest banks should be busted up into pieces. The only impediment to doing so, he said, is how.

"If you had a clear road map, I'd be for it," Bullard said Thursday at the Hyman P. Minsky Conference in New York. "If there was a good way to do so, if you had a clear road map about how you were going to go about it, and why you were going to break them up in this particular way."

Bullard, Hoenig and Fisher effectively represent bankers from Middle America. Hoenig repeatedly has talked about the tilted financial playing field that benefits Wall Street banks over Main Street banks. Fisher said Wednesday that megabanks pose such a danger that they can spread "debilitating viruses throughout the financial world," reiterating his call that megabanks should be broken up.

"I have a lot of sympathy for what they're saying," Bullard said. "I do kind of agree that 'too big to fail' is 'too big to exist'. The only thing that's making me hesitate about that are the details about how you would split up firms [and] why would you make them split up one way as opposed to another way.

"I haven't seen a lot on that, but I'm very sympathetic," he said. "But the devil's in the details about how you would actually break them up."

Hoenig has called for a partial return to the Glass-Steagall Act, the Depression-era law repealed at the urging of Clinton administration officials that long separated traditional banking from capital markets activities. A restoration of that divide, plus some additional action by policymakers, will break up today's megabanks, he says.

Fed's Fisher calls for break up of banks

Referring to the danger posed by megabanks as one that's able to spread "debilitating viruses throughout the financial world," a second top Federal Reserve official called for policymakers to bust up the nation's financial behemoths before they cause another worldwide financial crisis.

Richard W. Fisher, president and chief executive of the Federal Reserve Bank of Dallas, told a gathering of economists and financial experts Wednesday that "a truly effective restructuring of our regulatory system will have to neutralize what I consider to be the greatest threat to our financial system's stability... 'too big to fail'."

"In the past two decades, the biggest banks have grown significantly bigger," Fisher said in New York during a lunchtime speech that elicited rounds of applause. "The average size of U.S. banks relative to gross domestic product has risen threefold. The share of industry assets for the 10 largest banks climbed from almost 25 percent in 1990 to almost 60 percent in 2009.

"Existing rules and oversight are not up to the acute regulatory challenge imposed by the biggest banks," he said. So U.S. policymakers, along with their international counterparts, should come up with a system that will break them down into a manageable, less-risky size.

Fisher's comments echoed those from last month in which he also called for giant financial firms to be broken up. Along with Federal Reserve Bank of Kansas City President Thomas M. Hoenig, the two regional Fed presidents are arguably the most qualified and influential voices calling for a new blueprint for the nation's financial system -- a level playing field between Wall Street and Main Street, embodied in ending mega-institutions' dominance over the U.S. economy. Both are deficit- and inflation hawks and both represent the nation's heartland -- Kansas City and Dallas.

Their calls amplify what had been voices on the fringes calling for a fundamental redesign of the nation's financial system. It's not so easy for the White House, the Treasury Department, the Board of Governors at the Federal Reserve or influential members of Congress to dismiss calls to break up megabanks when two regional Fed presidents are calling for just that. Fisher and Hoenig, whose jobs put them above the partisan bickering in Washington, want to reform what's been laid bare as a broken and inefficient financial system.

"First, these large institutions are sprawling and complex -- so vast that their own management teams may not fully understand their own risk exposures, providing fertile ground for unintended 'incompetence' to take root and grow. It would be futile to expect that their regulators and creditors could untangle all the threads, especially under rapidly changing market conditions," Fisher said as he began his defense of his position.

"Second, big banks may believe they can act recklessly without fear of paying the ultimate penalty. They and many of their creditors assume the Fed and other government agencies will cushion the fall and assume some of the damages, even if their troubles stem from negligence or trickery. They have only to look to recent experience to take some comfort in that assumption," he said.

Then, Fisher went after the heart of the Obama administration's and Wall Street's central argument -- that the U.S. needs megabanks to compete on a global stage.

"Some argue that bigness is not bad, per se. Many ask how the U.S. can keep its competitive edge on the global stage if we cede LFI [large financial institutions] territory to other nations -- an argument I consider hollow given the experience of the Japanese and others who came to regret seeking the distinction of having the world's biggest financial institutions. I know this much: Big banks interact with the economy and financial markets in a multitude of ways, creating connections that transcend the limits of industry and geography.

"Because of their deep and wide connections to other banks and financial institutions, a few really big banks can send tidal waves of trouble through the financial system if they falter, leading to a downward spiral of bad loans and contracting credit that destroys many jobs and many businesses, creating enormous social costs. This collateral damage is all the more regrettable because it is avoidable."

Hoenig similarly discarded arguments favoring megabanks, referring to the ideas supporting them as "a fantasy -- I don't know how else to describe it."

"These costs are rarely delineated by analysts," Fisher said. "To get one sense of their dimension, I commend to you a thought-provoking paper recently written by Andrew Haldane, executive director for financial stability at the Bank of England.

"Haldane pulls no punches," Fisher said in a clear endorsement of Haldane's arguments. "He considers systemic risk to be 'a noxious by-product' or a 'pollutant' of an overconcentrated banking industry that 'risks endangering innocent bystanders within the wider economy.' He points out that the government's fiscal transfers made in rescuing or bailing out too-big-to-fail (TBTF) institutions -- whether they are repaid at a profit or not -- are insufficient metrics for tallying both the cost of the damage caused by their mismanagement and their subsequent rescues.

"Like me, he puts things in the perspective of the entire cardiovascular system and the body of the economy. He concludes: "...these direct fiscal costs are almost certainly an underestimate of the damage to the wider economy which has resulted from the crisis."

In fact, Haldane argues that "evidence from past crises suggests that crisis-induced output losses are permanent, or at least persistent, in their impact on the level of output." The "world economic output lost relative to what would have obtained in the absence of the recent crisis might be $60 trillion or more," Fisher said, referencing Haldane. "That's $60 trillion with a "T" -- more than four years' worth of American economic output."

While Haldane "may significantly overstate the real social costs of TBTF... the message is clear: The existence of institutions considered TBTF exacerbated a crisis that has cost the world a substantial amount of potential output and a whole lot of employment," Fisher said.

He went on to cite Haldane's study of the funding advantage enjoyed by TBTF institutions -- "which has widened during the crisis" -- and quoted a figure calculated by Dean Baker, co-director of the Center for Economic and Policy Research in Washington, who said that advantage amounts to a $34-billion-a-year taxpayer-provided subsidy for the 18 largest U.S. banks.

Haldane's study "simply adds grist to the mill of my conviction," Fisher said. "[B]ased on my experience at the Fed... the marginal costs of TBTF financial institutions easily dwarf their purported social and macroeconomic benefits. The risk posed by coddling TBTF banks is simply too great."

Based on Fisher's desire to break up the nation's biggest banks, the present financial reform proposals before Congress just don't go far enough.

"To be sure, having a clearly articulated "resolution regime" would represent a step forward, though I fear it might provide false comfort: Creditors may view favorably a special-resolution treatment for large firms, continuing the government-sponsored advantage bestowed upon them," he said. "Given the danger these institutions pose to spreading debilitating viruses throughout the financial world, my preference is for a more prophylactic approach: an international accord to break up these institutions into ones of more manageable size -- more manageable for both the executives of these institutions and their regulatory supervisors."

And if not possible to do this on an international level, then the U.S. should act unilaterally and go it alone, Fisher said.

"It would obviously take some work to determine where to draw the line," he said. "Haldane's paper suggests that 'economies of scale appear to operate among banks with assets less, perhaps much less, than $100 billion,' above which 'there is evidence... of diseconomies of scale'."

"[T]here are limits to size and to scope beyond which global authorities should muster the courage to draw a very bright, red line. I align myself closer to former Fed chairman Paul Volcker in this argument and would say that if we have to do this unilaterally, we should. I know that will hardly endear me to an audience in New York, but that's how I see it," Fisher said.

"Winston Churchill said that 'in finance, everything that is agreeable is unsound and everything that is sound is disagreeable.' I think the disagreeable but sound thing to do regarding institutions that are TBTF is to dismantle them over time into institutions that can be prudently managed and regulated across borders," Fisher said. "And this should be done before the next financial crisis, because we now know it surely cannot be done in the middle of a crisis."

Fed’s Hoenig backs bank break-ups where needed

"A top U.S. Federal Reserve official on Tuesday backed stripping banks of risky operations, suggesting growing support for breaking up large firms to prevent excesses that could undermine financial stability.

At a meeting of top economists here, Kansas City Federal Reserve Bank President Thomas Hoenig voiced support for former Fed Chairman Paul Volcker’s recommendation that banks not be allowed to sponsor hedge or equity funds.

However, also like Volcker, Hoenig stopped short of calling for restoration of Glass-Steagall banking laws that barred large banks from affiliating with securities firms and engaging in the insurance business.

Hoenig said areas where firms engaged in risky trading or “gambling” for their own account should be separated from commercial banking activities, as Volcker had suggested.

He told a panel at an American Economics Association conference it was important to safeguard the commercial banking sector from the riskier practices once the sole domain of investment banks, given the sector’s importance to both the U.S. and global economies.

Glass-Steagall barriers were largely repealed in 1999, a high-water mark for deregulation. Some members of Congress have proposed reinstating them as part of comprehensive financial reforms aimed at fixing flaws that set the stage for the worst financial crisis since the Great Depression.

However, some influential lawmakers, including Senate Banking Committee Chairman Christopher Dodd, have said restoring the walls between investment and commercial banking activities is unlikely.

Hoenig, an experienced bank regulator, made clear he was not advocating such a big step.

“We have to go back and think of some of the reasons why this came about at these very large institutions — without changing the structure that eliminated Glass-Steagall — and the consequences of that,” he said.

A bill to overhaul financial rules approved by the House of Representatives in early December would allow regulators to force firms to restructure or break up in extreme cases.

The Senate is expected to work on its version of the bill early this year. The two versions would need to be melded and approved by both chambers before the president could sign them into law.

Hoenig, who cut his teeth as a bank regulator shuttering institutions during the banking crisis in the early 1980s, has been a persistent advocate of making it impossible for financial firms to become so large or interconnected that markets believe the government would bail them out rather than let them fail.

He joins Dallas Federal Reserve Bank President Richard Fisher in advocating breaking up financial institutions to curb risks to the broader system.

Breaking apart very large firms “is a fair thing to consider,” he said."

Volcker on conflicts in commercial banking and prop trading

Stern: So, can we get from here to there, where commercial banks look much more like traditional commercial banks, and we leave things like proprietary trading and hedge fund activity and those kinds of things to other institutions? Can we get back to that kind of world?

Volcker: Well, I think we can, but obviously there’s a lot of opposition among banks. I actually don’t think it’s nearly as difficult as you might think. There aren’t many banks that own hedge funds or private equity funds. Where you do run into a problem is with trading, and there they’ll say, “We can’t serve customers; we can’t do underwriting without some trading activity.”

I think that’s right, but I think there’s a difference between that kind of activity—it’s probably a matter of scale—and what, let’s say, Goldman Sachs and some of the other banks are doing, where it has become a very major preoccupation, profitable or not.

I must say that when I talk to people in these institutions—people I know pretty well and trust—they say, yes, there is a difference between aggressive proprietary trading and the kind of thing that emerges in the context of customer relationships.

It’s only partly a prudential problem—particularly at a bank that has a large investment management business (and, of course, the big ones do). The problem is that it’s just an obvious conflict of interest between the hedge fund, the trading and the private equity business in what they’re doing advising their customers.

Tarullo on ineffectiveness of breaking up banks

"Federal Reserve Governor Daniel Tarullo said proposals to separate trading from deposit taking and lending at the biggest banks probably wouldn’t dispel the perception that some firms are too big to fail.

“Some very large institutions have in the past encountered serious difficulties through risky lending alone,” the central bank governor said in remarks yesterday to the Money Marketeers of New York University...

...Tarullo “was lobbying on behalf of the Fed’s positions,” said Ray Stone, a managing director at Stone & McCarthy Research Associates in Princeton, New Jersey, who attended the speech. “It comes down to capital requirements and liquidity requirements. Those are their main tools on the regulatory front.”

Tarullo cited “massive failures” in risk management inside financial firms, and “serious deficiencies” in government regulation as causes of the crisis.

Pose Threat

“As shown by Bear Stearns and Lehman, firms without commercial banking operations can now also pose a too-big-to- fail threat,” he said. Lehman Brothers Holdings Inc. collapsed into bankruptcy in September 2008, and Bear Stearns Cos. was merged into JPMorgan Chase & Co. with Fed assistance.

“Too-big-to-fail perceptions weaken normal market disciplinary forces,” Tarullo said. Splitting apart commercial and investment banking activities “would seem unlikely to limit the too-big-to-fail problem to a significant degree.”

Volcker said in Sept. 30 remarks in Gothenburg, Sweden that banks don’t “have any real business in doing a lot of speculative trading.”

Tarullo said in response to an audience question that legislators will need to address the U.S. fiscal imbalance and Fed officials will be watching their efforts with “considerable interest.”

Greenspan on breaking up the TBTF banks

"U.S. regulators should consider breaking up large financial institutions considered “too big to fail,” former Federal Reserve Chairman Alan Greenspan said.

Those banks have an implicit subsidy allowing them to borrow at lower cost because lenders believe the government will always step in to guarantee their obligations. That squeezes out competition and creates a danger to the financial system, Greenspan told the Council on Foreign Relations in New York.

“If they’re too big to fail, they’re too big,” Greenspan said today. “In 1911 we broke up Standard Oil -- so what happened? The individual parts became more valuable than the whole. Maybe that’s what we need to do.”

At one point, no bank was considered too big to fail, Greenspan said. That changed after the Treasury Department under then-Secretary Hank Paulson effectively nationalized Fannie Mae and Freddie Mac, and the Treasury and Fed bailed out Bear Stearns Cos. and American International Group Inc.

“It’s going to be very difficult to repair their credibility on that because when push came to shove, they didn’t stand up,” Greenspan said.

Fed officials have suggested imposing a tax or requiring higher capital ratios on larger banks to ensure the firms’ safety and reduce some of the competitive advantage from the implied subsidy. Greenspan said that won’t work.

“I don’t think merely raising the fees or capital on large institutions or taxing them is enough,” Greenspan said. “I think they’ll absorb that, they’ll work with that, and it’s totally inefficient and they’ll still be using the savings.”

The former Fed chairman said while “just really arbitrarily breaking down organizations into various different sizes” goes against his philosophical leanings, something must be done to solve the too-big-to-fail issue.

“If you don’t neutralize that, you’re going to get a moribund group of obsolescent institutions which will be a big drain on the savings of the society,” he said.

“Failure is an integral part, a necessary part of a market system,” he said. “If you start focusing on those who should be shrinking, it undermines growing standards of living and can even bring them down.”

Former Citi CEO on separating commercial/investment banking

To the Editor:

Re “Volcker’s Voice, Often Heeded, Fails to Sell a Bank Strategy” (front page, Oct. 21):

As another older banker and one who has experienced both the pre- and post- Glass-Steagall world, I would agree with Paul A. Volcker (and also Mervyn King, governor of the Bank of England) that some kind of separation between institutions that deal primarily in the capital markets and those involved in more traditional deposit-taking and working-capital finance makes sense.

This, in conjunction with more demanding capital requirements, would go a long way toward building a more robust financial sector.

John S. Reed New York, Oct. 21, 2009

The writer is retired chairman of Citigroup.

Experts say bills won't end "too big to fail"

We at Planet Money did an informal survey of economists and regulatory experts on the left and the right. We couldn't find any who fully endorse the reforms backed by President Obama and Democrats in Congress.

Everyone thinks the reforms just aren't enough to solve the problem.

Take, for example, "too big to fail" -- the idea that if one of the largest banks in the country gets into trouble, the government will save it with taxpayer money.

"A vote for reform is a vote to put a stop to taxpayer-funded bailouts," Obama said in his speech in New York on Thursday.

I cannot find any experts -- of any party -- who are willing to agree with Obama on this one.

"We're not seeing a very forceful step on the too-big-to-fail-problem," said Carmen Reinhart, an economist at the University of Maryland. "If there's any doubt that the crisis may be systemic, we will bail out again."

So, if a major bank says, "Hey, save us or the economy will go under," the government's going to save the bank. Full stop.

We did find one expert, Doug Elliott of the Brookings Institution, who is actually a huge fan of the regulatory reform bills. He says they bring a bunch of changes that make our economy safer.

But they don't end too big to fail, he said. The only way to do that is to break them up so that "they're so small that we don't care" if they fail.

This is close to a consensus view among the experts. Some say that's a good idea, some say it isn't. But most say that unless you chop up the big banks into lots of small banks, you won't end too big to fail.

Johnson on the historical need to regulate big banks

Just over 100 years ago, as the 19th century drew to a close, big business in America was synonymous with productivity, quality and success.

“Economies of scale” meant that big railroads and big oil companies could move cargo and supply energy cheaper than their smaller competitors and, consequently, became even larger.

But there also proved to be a dark side to size, and in the first decade of the 20th century mainstream opinion turned sharply against big business for three reasons.

First, the economic advantages of bigness were not as great as claimed. In many cases big firms did well because they used unfair tactics to crush their competition. John D. Rockefeller became the poster child for these problems.

Second, even well-run businesses became immensely powerful politically as they grew.

J.P. Morgan was without doubt the greatest financier of his day. But when he put together Northern Securities — a vast railroad monopoly — he became a menace to public welfare, and more generally his grip on corporations throughout the land was, by 1910, widely considered excessive.

Third, there was a blatant attempt to use the political power of big banks to shape the financial playing field in ways that would help them (and their close allies) and hurt the remainder of the private sector — including farmers, small businesses and everyone else.

Senator Nelson Aldrich’s push to create a central bank after 1907 — to be underwritten by the government but controlled by big banks — ultimately backfired. The Federal Reserve, while far from perfect, was created with far greater public control and more safeguards than Wall Street had in mind.

The fact that Nelson Aldrich’s daughter was married to John D. Rockefeller’s son was not lost on anyone.

A hundred years later, we have come full circle, as the mainstream consensus again weighs what to do with today’s overly powerful banks.

There are differences, of course. We no longer fear individuals; it’s the organizations they run that can make us or break us.

And, strangely, it is not the power of big finance to control everything that has us worried — except maybe in some movies. Rather it’s the ability of major banks to generate the conditions that make major international financial crises possible — with the incentive to take risks that, when things go well, result in huge upside for bankers and, when things go badly, massive downside for the rest of us.

Even the supporters of our existing financial structure — men like former Treasury Secretary Henry M. Paulson Jr. (in his book “On The Brink“); the White House economic adviser, Lawrence H. Summers (in his 2000 Ely Lecture); and JPMorgan Chase’s chief executive, Jamie Dimon — concede that big crises occur every five years or so. What hit us in 2008-9 was not a “once per century” event. Rather it was the latest, and scariest, in a series of regular global crises going back at least to the 1970s.

At the heart of this pattern of behavior is a perception of invincibility among the folks who run our biggest banks — and following our most recent crisis they act more assured than ever that the government will provide a backstop.

At the same time, everyone agrees that such “too big to fail” arrangements cannot continue. Even the Federal Reserve, which has fallen on hard and embarrassing times since it was captured by Big Finance during the 1990s, now has its leading officials give speeches to this effect.

We like to think we live in a more professional and technocratic age than a century ago, so the central pretense of current reform efforts is that we can design a “resolution authority” of some kind that would allow the government to take big banks into a form of bankruptcy or liquidation.

But this notion of a resolution authority that can handle massive banks is a complete unicorn, a mythical beast with magical powers that does not really exist. A United States-run resolution authority does nothing to help handle the failure of international banks; there is no cross-border resolution authority, nor will there be one anytime soon. If a Citibank or a JPMorgan Chase or a Goldman Sachs were to fail, our government would be in exactly the same awkward position as it was in September and October 2008.

Big banks cannot be reined in through some clever tweaking of the rules. The issue before us is intensely political, just as it was in the first decade of the 20th century. There is again a confrontation between concentrated financial power and our democracy. One side will win and the other side will lose.

The banks start with a definite edge. The public relations machines of today’s bankers may be even more effective than those of Morgan and Rockefeller, although the campaign contributions and control of the Senate exercised by those titans was immense.

The Senate legislation expected this week or next will achieve nothing, except make the stakes clearer and the motivations more transparent. If the banks win this round, as seems likely, they will become even larger — and more dangerous. At current scale, our megabanks bring no social benefits and great social risks.

Just as it did 100 years ago, the consensus on big banks has to change. In this instance, either we break them up, or they will soon break us all.

Stiglitz urges nationalizing banks

Nobel Prize-winning economist Joseph Stiglitz said the world’s biggest economy is suffering because of the U.S. government’s failure to nationalize banks during the financial crisis.

“It we had done the right thing, we would be able to have more influence over the banks,” Stiglitz told reporters at an economic conference in Shanghai yesterday. “They would be lending and the economy would be stronger.”

Stiglitz has stuck with his view even after the U.S. economy returned to growth in the third quarter and as banks’ share prices climbed this year. President Barack Obama said on Oct. 24 that the nation’s lenders, supported by taxpayers in the crisis, need to “fulfill their responsibility” by lending to small businesses still struggling to get credit.

Companies such as Citigroup Inc. and Bank of America Corp. benefited from a $700 billion taxpayer-funded bailout package last year. In contrast, Obama said that too many small businesses are still short of money, adding that his administration will “take every appropriate step” to encourage banks to lend.

“We have this very strange situation today in America where we have given banks hundreds of billions of dollars and the president has to beg the banks to lend and they refuse,” Stiglitz said yesterday. “What we did was the wrong thing. It has weakened the economy and has increased our deficit, making it more difficult for the future.”

While the U.S. economy grew at a 3.5 percent annual rate in the third quarter, the first expansion in more than a year, the economist said the recession is “nowhere near” its end, citing rising unemployment and weak demand.

The U.S. government plans to alter the way that a similar rescue would be handled in the future. Draft legislation proposes that banks, hedge funds and other financial firms holding more than $10 billion in assets would pay to rescue companies whose collapse would shake the financial system.

Citigroup and Bank of America shares have quadrupled from this year’s lows in March.

Baker on breaking up the banks

Those who like banks that are too big to fail will love the latest financial reform proposals circulating in the US Congress. The bill put forward by Barney Frank, the chairman of the House finance committee, does little to change the current structure of the financial system.

The "too-big-to-fail" banks will be left in place, even bigger and less accountable than before. There will be nothing done to separate commercial and investment banking, so giants like Goldman Sachs will be free to speculate with money guaranteed by the Federal Deposit Insurance Corporation. The main difference is that the Federal Reserve Board will be granted even more power than it has now. And, we will tell the Fed to be smarter in the future, so that it doesn't make the same stupid mistakes that gave us the current crisis.

While we all want a smarter Fed, it is not clear that the bill before Congress will get us one, even though it will definitely give us a more powerful Fed. The new Fed will be able to decide which financial firms need to be put through a bankruptcy-like resolution process, paid for with a virtually unlimited amount of taxpayer dollars.

While the bill proposes that the cost of cleaning up after a big bank failure is supposed to be paid by other big banks, in fact the mechanism laid out in the bill virtually guarantees the opposite. Rather than raising a pool of money in advance from the big banks to cover the cost of a bailout, the bill proposes that large banks would be assessed a special fee only after a failure.

To see how strange this is, suppose Citigroup or some other major bank collapsed, requiring $100bn to pay off creditors. (We actually should not need a penny to pay off anyone other than insured depositors if we were serious about the banks not being too big to fail.) Either the failed bank was acting as a rogue institution, engaging in behaviour that was far more reckless than its peer institutions, or it was doing the same thing as everyone else.

In the first case, would it make sense to tax the other large banks $100bn because Citigroup acted recklessly? If the recklessness of one bank had led to its collapse in an environment where its competitors are sound, this would imply that there had been some serious failures of regulation. Why would we tax other large banks because the Fed, the FDIC and/or other regulatory bodies had failed in their job?

Alternatively, suppose Citigroup collapses because it was doing the same thing as other banks, but was just slightly more reckless or unlucky. In this situation, which is similar to the one we faced last fall, all of the banks would be severely stressed. It would be impossible to hit them with a special fee. Could we have slapped a special fee on Citigroup and Bank of America last autumn to have them cover the cost of the failure of Lehman Brothers? At the time, imposing any significant fee would have almost certainly pushed several more banks to insolvency.

The bottom line is that this bill is almost certain to leave the taxpayers holding the bag for future bailouts. Even worse, it does nothing about the moral hazard created by having institutions that are too big to fail. There is nothing in the bill to lead creditors to believe that the government will not make good on their loans to Goldman, JP Morgan and the other banking behemoths.

There is a large and growing consensus across the political spectrum for breaking up banks that are too big to fail. Advocates of this position include former Federal Reserve Board chairmen Paul Volcker and Alan Greenspan; Sheila Bair, the current head of the FDIC; and Simon Johnson, the former chief economist of the International Monetary Fund. There is no reason that we need financial institutions that are so big that they cannot be safely unwound without large commitments of government money.

The only people who seem to stand outside this consensus are those who hold power and are steering the process of financial reform. This is largely the crew whose regulatory failures gave us the current disaster. If they cannot learn from their mistakes then someone else will have to drive the reform process."

Roubini on breaking up the TBTF

"It is time to deal with the so-called “too-big-to-fail” financial institutions, an issue that has only been exacerbated by the various government bail-outs. That is according to Nouriel Roubini, Professor of Economics Stern School of Business, who was speaking at the Irish Financial Services Summit in Dublin yesterday.

Roubini, who earned the nickname "Dr Doom" when he consistently predicted the current financial crisis as far back as 2006, pointed out that the bail-outs had only led to even further consolidation of the financial institutions into even larger behemoths. "In my view an ideal financial system is not one with financial supermarkets. I think the arguments in favour of the financial supermarkets have been overstated. You see what happened with Citi where the financial supermarket model has been disastrous. Putting together commercial banking, investment banking, insurance, asset management - you name it - just doesn't make sense."

“The complexities of managing such an entity are such that no human being, no CEO or board can do it. It's just mission impossible. In my view banks should be banks and deal mostly in providing credit to the real economy. Investment banks should be involved in mostly what the broker dealers do, that is underwriting. And prop trading should be left essentially to other financial institutions who do investments, like hedge funds, private equity and other ones."

“There is no reason why a shareholder in a bank should be taking risk that is credit risk, underwriting risk and prop trading risk...and commercial banks who have access to the safety net of the Government should be involved only in activities that are less risky," Roubini continued.

He added that there were many other items on his 'shopping list' to create a more stable financial system. "We need more global supervision and regulation of financial institutions that are systemically important. We need more transparency absolutely because a lot of the financial system, in terms of transactions, instruments and players, have become more opaque and less transparent. And when there's no transparency then people in a situation of stress run to the exits."

“I think that overall we need less leverage, because leverage is what essentially kills the financial system, and leverage is also what kills the economy. So a world in which there is less leverage, and more reliance on equity financing is an important one. We also need to deal with the distortions that have been created by the conflicts of interest of rating agencies. That is a key issue..."

Giant hedge funds backed by the US's "full faith and credit"

"Just imagine how angry the American public would be if they knew the whole story.

For months, we have listened to the whining from Wall Street. U.S. banks are having a record year, and they want to be paid a lot of money. Billions and billions of dollars.

Public indignation is deep. After all, over the past year, we have watched as hundreds of billions of dollars of public money has been poured into bank balance sheets. We have--we are assured--taken steps that were necessary to bring our financial system back from the brink. We may not have liked it, but we had no choice.

But now that we have stemmed the tide, now that the Great Panic of 2008 has abated, we have been forced to watch these same institutions moan about how bad they have it. Citigroup --the one that received $45 billion in taxpayer funds, plus a couple hundred billion extra in public underwriting of bad assets--wants to wipe the slate clean by paying the money back and calling it even. So they can pay themselves billions of dollars in bonuses.

Wells Fargo, the arriviste among the financial elite, is complaining about the competitive disadvantages that they face as a consequence of federal compensation constraints. Constraints that prevent them from paying themselves billions of dollars in bonuses.

Goldman Sachs--caught in a lie by a federal Inspector General who refuted Goldman's sanctimonious claim that even if the world had collapsed, they would have been fine--is trying to fend off accusations of unwarranted hubris and greed--which reached a pinnacle when they announced plans to pay themselves $21 billion in bonuses--by announcing that their senior partners will take their share of the billions in stock.

But what if the public understood the whole story? How is it that the banks are now having one of their most profitable years ever? Given that there is not much lending going on, and that the newly increased credit card fees have only just begun to flow into bank coffers, where is all that money coming from?

It is coming from proprietary trading. "Prop trading" is the kind of betting with the bank balance sheet that was made illegal for commercial banks back during the Great Depression, when the FDIC and deposit insurance was created. The price of having the federal government guarantee bank deposits was separating the lending and depositary functions of commercial banking from trading and risk activities of investment banking. Thus, in 1935, the commercial bank J.P. Morgan & Company was separated from the investment firm Morgan Stanley.

But this separation was undone in 1999 to facilitate the creation of the megabanks that we have today. However, the Financial Services Modernization Act of 1999 ended the separation of activities, FDIC deposit insurance remained in place. And this year, the elite of the financial world--JP, Citi, Wells, BofA, Goldman and Morgan Stanley--have finally emerged for what they are: Gigantic hedge funds backed up by the full faith and credit of the United States of America. Wall Street bankers making big bets with our money, content in the knowledge that if they win their bets, they will pocket the cash. And if they lose, we will all pick up the mess.

But it really does get better. So exactly how did they make all that money this year?

Well, the trade of the moment has been the U.S. dollar carry trade. A foreign currency carry trade is simple in concept. Borrow money where interest rates are low, and invest where interest rates are high. Or simply stated: Short the U.S. dollar. Buy the currency of a country where interest rates are higher. The beauty part is that by continually assuring the world that U.S. interest rates will remain near zero for the foreseeable future, the Federal Reserve has assured traders that they can keep the trade in place for some time.

So the Wall Street elite, just months removed from their near-death experience, are now making a fortune shorting the U.S. dollar. One year ago, faced with the greatest financial panic in generations, the American people swallowed hard and bailed out the banks. Today, the banks have moved on, and are tearing down the currency of the nation that saved them.

But it is nothing personal. It is strictly business.

And the carry trade will work out fine. Until it doesn't. Then the trade will unwind quickly, and those who do not get out in time will get hurt badly.

But the banks are not worried. If the unwinding of what NYU economist Nouriel Roubini has labeled "the mother of all carry trades" takes a bank or two down with it, everything will be all right. Because the bank deposits are still insured, and we now know to an absolute certainty that if one of the elite institutions fails, we will bail it out. Again.

It is time that we come to grips with the depravity of the current situation, and potential damage that continuing down this path may yet do to the financial system and to our economy.

Our commercial banks are not, and should not be, hedge funds. U.S. dollar carry trades and writing credit default swaps are not core commercial banking functions. They are not necessary to the efficient functioning of our financial system.

The U.S. dollar carry trade is destructive to our currency, and is creating asset bubbles across the world, as leverage is transferred from our markets into others. For their part, credit default swaps serve no useful purpose in proportion to the systemic risks they create.

It is time to go back to basics. Commercial banks provide essential services in our economy. They enable the Fed to control the distribution and pricing of capital to the productive sectors of the economy. They provide secure depositary and asset management services.

Unfortunately, pending Congressional legislation has done nothing to address the central risks that the new financial landscape presents to our economy. Rather than reinstitute restrictions on bank activities or restrain institution size, Congress is looking to regulatory solutions that hold little promise of success when the next crisis emerges. And rather than recognizing the problem of moral hazard, this week Congress took the first step of embracing it in statute.

This year, Wall Street has shown its true colors, but the public has yet to understand the depth of the betrayal. It is not the continuing absence of lending, or jacking up credit card fees, or hiking consumer interest rates, or even the constant refrain of complaints about limitations on executive compensation. No, the greatest betrayal is that with the American economy as weak as it has been in years, with the dollar weakness threatening to unravel the international commitment to the role of the dollar as the reserve currency, Wall Street has shown no shame about attacking the currency of the nation that came to its aid.

If this is the path that the elite commercial banks have chosen, if they have been fully seduced by the lucre of trading, Congress needs to revisit the fundamental rules of the game, and revisit the central rationale for deposit insurance and the structure of the commercial banking system.

Global commentators on breaking up banks

UK government commission to investigate splitting up banks

The new coalition government in the UK is to establish a commission to look into splitting up investment and retail banking operations in the country.

It included the pledge as part of its program of policies for the next parliament and said it would give the new commission 12 months to come up with its findings on how it could be done.

The document also laid out a number of other regulatory measures it wishes to apply to the financial services industry in the UK.

"We will reform the banking system to avoid a repeat of the financial crisis, to promote a competitive economy, to sustain the recovery and to protect and sustain jobs," the government said of its overall aims.

It added that measures including a banking levy, tackling "unacceptable bonuses" and reform the current system of financial regulation will all be implemented.

Last week, British opposition to tougher new rules on hedge funds operating in the European Union was defeated as the measures were passed in Brussels.

British central banker favors splitting big banks

Mervyn A. King, the governor of the Bank of England, is an owlish, self-effacing man who, in contrast to his more outspoken peers in Frankfurt and Washington, strikes a public posture that borders on the demure.

Last week, such a proposal pushed by the former Federal Reserve chairman Paul A. Volcker made headway. President Obama shocked Wall Street by proposing that large banks that collect customer deposits be banned from engaging in proprietary trading activities.

At a hearing before a parliamentary treasury committee on Tuesday, Mr. King used some of his strongest language yet to support such a separation. In the process, he hailed Mr. Obama for having moved so quickly.

“The U.S. has been more open in moving to a safer banking system than we are,” he said. “After you ring-fence retail deposits, the statement that no one else gets bailed out becomes credible.”

To illustrate his point that increased regulation and higher capital requirements alone would not be sufficient to forestall another banking crisis, he pointed to Citigroup — which once was seen as a model for combining all banking functions under one roof.

“You had regulators in the building and four of the most respected people in the world running the bank,” he said, citing its architect, Sanford I. Weill; the former Treasury secretary Robert E. Rubin; the former International Monetary Fund official Stanley Fischer; and a veteran international banker, William Rhodes.

“They did not set out to destroy Citibank, but when you have a large complicated institution, things happen,” he said. “That is the argument for trying to create firewalls.”

Under post-Depression laws, bank holding companies in the United States were not allowed to own investment banks before 1999. But in Europe, no such division ever existed.

In fact, until last week such a notion had been roundly criticized, more a provocative debating point in an academic seminar than a practicable piece of legislation. Others speculated that the idea would surely be swatted away by muscular banking lobbies if it ever came close to becoming law.

Indeed, some see the idea, far-fetched and steeped in principle as it may be, as more an emblem of Mr. King’s own unyielding sense of what is right and what is wrong for the markets — albeit one that in this case is in tune with the public mood.

“I think Mervyn is a little more fixated on moral hazard than others,” said DeAnne Julius, a prominent economist here, referring to the view that rescuing banks via bailouts or sharp cuts in interest rates just encourages more of the risky conduct that got them in trouble in the first place.

Ms. Julius, a former member of the central bank’s policy-making committee, disagrees with Mr. King’s bank proposal. But she acknowledged that “he believes strongly in the rigors of market discipline, and he has a tendency to stay with a theory and get the world to conform to it.”

Prime Minister Gordon Brown, who earlier fired his own cannonball at bankers with his proposal for 50 percent tax on bonuses, said on Tuesday that British banks were not in need of such a change.

Last month Robert Diamond Jr., the president of Barclays, which with its substantial trading business would be one of the banks most affected, gave a series of speeches defending the universal model.

“Banks are bound to fight,” Mr. King said in his testimony.

Mr. King’s arguments were delivered with a severity that reached beyond his view that banks that had become larger and more profitable since the crisis must be shrunk.

A former finance professor at the London School of Economics, Mr. King, 61, is known as a ferocious worker.

And in 2007, as central banks in the United States and Europe aggressively cut interest rates, Mr. King stubbornly kept British rates fixed, arguing that any such loosening would unfairly reward bad banking behavior.

After the failure of Northern Rock and the collapse of Lehman Brothers, Mr. King shifted course. The Bank of England has become perhaps the most aggressive central bank in terms of adding liquidity to the economy by buying government bonds.

But after this unprecedented action, Mr. King has become even more doctrinaire in his view that the large banks that have benefited be forced to pay a price, one that would ensure that they never again threaten the viability of the world financial system.

In his testimony, Mr. King said he had been thinking about how to address the dangers of big banking since 2007, at the first signs of the crisis.

But it was not until last June, during a speech before the financial industry, that he first suggested that only through such a breakup could bankers reclaim public trust.

“ ‘My word is my bond’ are old words,” he said dryly as London’s banking elite tucked into their filet mignon dinners. “ ‘My word is my C.D.O.-squared’ will never catch on,” he added, using the abbreviation for collateralized debt obligation, one of the financial instruments that were blamed for precipitating the financial crisis.

Since that speech, Mr. King has become a cult hero of sorts to many academics and others who advocate even harsher measures to keep banks on the straight and narrow.

One who has had his ear is Laurence J. Kotlikoff, a professor at Boston University who wants all financial institutions — from hedge funds to private equity funds as well as investment and commercial banks — to reconstitute themselves as mutual funds, meaning they would not be allowed to borrow to increase the size of their investments. The goal would be to prevent the types of debt-fueled bets that had such dire consequences.

That Mr. King would just about endorse such a proposal for the entire financial industry — he referred to Mr. Kotlikoff twice in his testimony on Tuesday — suggests that he may be inclined to push further than Mr. Obama.

“He is interested in this idea,” said Mr. Kotlikoff, who presented his idea to Bank of England officials last November and says he will do so again next month. “And he understands the depth of the problem.”

Swiss central banker backs universal bank model

Switzerland’s two big banks — UBS and Credit Suisse — should not be forced to split their wealth management and commercial banking operations into separate entities, the new head of the country’s central bank said on Saturday.

Philipp Hildebrand, who took over as chairman of the Swiss National Bank at the start of the month, said the universal banking model provided useful synergies for Swiss banks.

Hildebrand has said repeatedly that major Swiss banks need tighter regulation to deal with the “too big to fail” problem.

But he said in an interview in the Swiss daily Le Temps that something as radical as the Glass Steagall Act, which previously separated investment and commercial bank functions in the United States, would not make sense in Switzerland.

“The universal banking model represents a form of risk diversification,” Hildebrand was quoted as saying.

He recalled that in the 1980s Swiss banks had been able to absorb losses — amounting to some 40 billion Swiss francs ($39.10 billion at today’s rates) in their traditional mortgage business thanks to profits in the investment banking side.

At the same time wealth managers needed to be able to offer their ultra-rich customers the full range of investment banking services, for instance to help with in mergers and acquisitions involving companies they own, he said.

“These services must be offered to clients and used to attract them for wealth management business,” he said.

It is imperative, however, that some activities within the universal banking model, such as proprietary trading, are not allowed to imperil the stability of the financial system, he said.

Hildebrand said that the relatively large weight of the two banks in Switzerland’s economy, compared with banks in other centres, could force Switzerland to regulate more strictly than other jurisdictions.

He said that the strongest selling point for Swiss banks was to be based in a stable financial centre.

“The foundation of our financial centre remains wealth management, for which confidence is essential,” he said.

From the point of view of stability, it is vital that the large profits now being made by banks , and which in part are due to central bank policies or intervention, do not disappear into bonuses, dividends or share repurchases but are used to strengthen the capital of the bank, he said.

He noted that the authorities in Switzerland as in many other countries had the power to intervene in banks’ dividend distribution policies.

Banker ‘oligarchs’ block break-up moves, Kay says

"Investment bankers are wielding their political influence to override popular support for legislation to break up lenders’ trading and retail operations, economist John Kay said.

“You have a group of politically powerful oligarchs, whom other people hate, but who are entrenched there,” Kay, a visiting professor at the London School of Economics, said in an interview yesterday. “It will require something of a political earthquake” to reduce the bankers’ sway, he said.

Bank of England Governor Mervyn King said in September that a debate on the structure of banking is needed and described an article by Kay as “the most important piece written on the subject in 10 years.” King also cited Kay as he argued in a speech last month for splitting retail operations from investment banking.

“I’m struck actually when I talk to an audience like this, or indeed to people in the City who are not investment bankers, how much support for breaking up the banks there is,” said Kay, who was speaking after a debate in London.

Prime Minister Gordon Brown said on Oct. 21, the day after King’s speech, that “the difference between having a retail and investment bank is not the cause of the problem, the cause of the problem is that banking has not been sufficiently regulated.” Brown faces an election by June.

“There’s something unreal about where we are at the moment,” Kay said. “It’s in some ways the product of this dying government. It’s a strange era.”

Conservative Policy

The opposition Conservatives are “genuinely interested” in separating bank operations, though “it’s harder for Conservatives to do and the truth is, they’re pretty dependent on the financial services sector as well,” he said.

Kay, who co-authored a book on taxation with King two decades ago, said that banking regulation should aim not to prevent insolvencies, but to curb their effects.

“It’s the same as when any other company goes bust -- it will spread to other companies, but you have to limit it,” Kay said. He cited the example of Lehman Brothers Holdings Inc.’s collapse in September last year, which exacerbated the global financial crisis.

“The idea is to create sufficient breaks between Lehman and the financial services system,” he said. “We absolutely need to ensure that you can let Lehman go down without too much problem.”

The solution is to structure the financial system in two parts, Kay said.

‘Pure Utility’

“One, which one might describe as a pure utility, is the payments system and the deposit element of it,” he said. “That is what you have to ring-fence.”

Kay said that oversight of such banking operations should be akin to regulation of utilities, citing examples of U.K. transport insolvencies. “When Railtrack when bust, the trains kept running,” he said.

“Then there’s the competitive product bit, savings products and such,” he said. As with food or fuel, “the government stands in the background and will intervene on major interruptions of supply, but you don’t expect that to happen.

“Actually, it’s rather easier for government to intervene in that way in the credit markets than it is in the food market because they can print the credit,” Kay said.

Bailout Support

Such reform is needed to prevent banks from always relying on state support, which encourages risky behavior. The result of the financial crisis at this point is that bankers “have learned the taxpayer will be there on a scale you could never have believed,” he said.

Kay spoke after an event at the Royal Society for the encouragement of Arts, Manufactures and Commerce, known as the RSA. He then delivered a lecture late yesterday hosted by the Institute of Economic Affairs in London and chaired by Bank of England Deputy Governor Paul Tucker.

Kay, explaining his views on regulation, said that the British government should be prepared to act “unilaterally” on legislation to separate banking operations, instead of waiting for international agreement on a coordinated approach."

Financial Times commentary

"In coming up with solutions that address the immediate crisis but fail to tackle dangerous systemic issues, the Group of 20’s emerging ideas on the banking industry bear a striking resemblance to the Americans’ response to the dotcom crash of 2001-02. Back then, the burst bubble exposed biased research and stock price manipulation on Wall Street and dubious accounting practices in US companies. Out came a new set of rules cleaning up the links between research analysts and investment bankers and laying a heavy hand on corporate chief executives.

These measures extinguished the fire but neglected more fundamental problems. By the time the regulations were in place, the investment banks and elements of the corporate sector were already deeply involved in new and even more dangerous practices. We speak, of course, of the derivatives-based leverage of banks’ balance sheets that brought down a range of previously sound institutions, dragged the global economy into recession and ripped up accepted economic theories.

We see exactly the same mistakes being made this time around. If effectively implemented (not the only possible outcome), the G20 finance ministers’ steer towards more and better capital, constraints on leverage and contingency plans for banking failures would help to avoid a repetition of the current crisis. But they are barely sufficient to give the financial services system the kind of radical overhaul it needs.

That would entail tackling a defective business model. Banks are allowed to mix plain vanilla deposit-taking and lending with high-risk investment banking. They are allowed to act for clients on both sides of a trade and take a proprietary turn out of the middle. In capital markets transactions they are able to act for those seeking capital and those providing it. Conflict of interest is embedded and this is unfair on other market users. It is “heads we win, tails you lose” as the banks make off like bandits in the good times and become pious onlookers as the taxpayer foots the bill when it all goes wrong.

Fixing the system requires this business model to be broken up and we would go beyond conventional Glass Steagall type solutions. Activities such as corporate finance, providing advice for investors and proprietary trading should be separated from each other as well as being split off from deposit-taking. This would create smaller, less profitable institutions and solve a number of problems, many of which have been caused by financial institutions over-trading. The system we advocate would restore the balance of economic power towards industries other than finance. It would stem the flow of capital that goes into bankers’ bonuses (a problem that the proposals coming out of G20 seem unlikely to solve) and would rid the world of financial institutions that were too big to be allowed to fail.

Many heavyweight thinkers have dismissed narrow banking (a less radical option than the one we advocate) as, to quote Lord Turner, chairman of the UK’s Financial Services Authority, “not feasible”. They point out that although Northern Rock was not an investment bank and Lehman was not a deposit-taking bank, both failed. This is another example of fighting the last war. The real problems are not the specific causes of the crises of 2008 (banks) or 2001 (dotcom) or 1998 (Long-Term Capital Management) or 1989 (US Savings and Loans), but the enduring power of finance to be socially and economically disruptive.

We do not expect politicians and regulators to restructure the global financial services industry at what is still a critical moment for the economy. But it is regrettable that they appear to have shut the door on even having such a conversation. A starting point, as we have argued before, would be to set up a banking commission informed but not dominated by people from outside the industry. Its remit would be to consider structural change and how the financial services industry can serve the wider social and productive needs of the economy.

This crisis has offended people’s basic notions of fairness. The connection between effort and reward must be proportionate and the playing field needs to be level if we are to secure a fully functioning market economy underpinned by political stability. That is why there is no option but to start the discussion we advocate."

Shadow Banking: What It Is, How it Broke, and How to Fix It

Downsizing can begin with the following set of actions:

  • All bank assets and liabilities must be brought onto balance sheets, and made subject to reserve and capital requirements and—more importantly—to normal oversight by appropriate regulatory agencies. Any assets and liabilities that are left off balance sheet will be declared null and void, unenforceable by US courts.
  • All CDSs must be bought and sold on regulated exchanges; otherwise they will be declared unenforceable by US courts.
  • Unless specifically approved by Congress, securitization of financial products such as life insurance policies will be prohibited and thus unenforceable by US courts.
  • The FDIC will be directed to examine the books of the largest 25 insured banks to uncover all CDS contracts held. These will then be netted among these 25 banks, canceling CDS contracts held on one another. CDS contracts with foreign banks will be unwound. The FDIC will also examine derivative positions with a view to determine whether unwinding these would be in the public interest.
  • In its examination, the FDIC will determine which of these banks is insolvent based on current market values—after netting positions. Those that are insolvent will be resolved. *Resolution will be accomplished with a goal of
    • i) minimizing cost to FDIC and
    • ii) minimizing impacts on the rest of the banking system.

It will be necessary to cover some uninsured losses to other financial institutions as well as to equity holders (such as pension funds) arising due to the resolution.

These actions should substantially reduce the size of the financial sector, and would eliminate some of the riskiest assets, including assets that serve no useful public purpose.

The financial system would emerge with healthier institutions and with much less market concentration.

Failing that, we should at least have the government get into the insurance business as credit insurer of last resort. Private firms can’t do it, as they do not have the financial resources to meet the potential claims (see AIG). And private firms have a tendency to mis-price credit risk (again, see AIG), which creates further incentives to bad behaviour.

As "Credit Insurer of Last Resort" (see Professor Perry Mehrling’s paper inventing this term – pdf), the government can charge proper premiums for it, which will have the additional impact of mitigating the worst behaviour of Wall Street. The government can put a floor on the value of the best collateral in the system. As Mehrling says (in a variation of the Bagehot rule – i.e. "lend freely but at a high rate during a crisis"): “Insure freely but at a high premium.”

UK Chancellor Darling says huge banks 'could be broken up'

"The huge financial groups created during last autumn's banking crisis may face being split up in the future, the chancellor Alistair Darling has said.

Mr Darling told the BBC's Politics Show Scotland that RBS and the Lloyds Banking Group may "need to divest themselves" of some of their business.

EU regulations about market domination may force banks into the move, he said.

Mr Darling was speaking exactly a year since three of the UK's biggest banks were bailed out by the government.

In response to the global financial crisis, the UK government nationalised Northern Rock and Bradford and Bingley, and put £37bn of capital into RBS, Lloyds TSB and HBOS.

The taxpayer now owns 43% of Lloyds Banking Group - which took over HBOS - and 70% of RBS.

However, the chancellor told the BBC that the EU's competition commissioner may force the sell-off of some of the banks' empires.

He said: "The new management at RBS have been going through all the books, root and branch, and they've already decided there's some things they had in the business which they don't see as core to what they do and over time they will seek to sell it.

"They key thing is that none of this, even if the European Commission says they've got to do this or that, is not going to happen tomorrow morning.

"The commission have made it quite clear to us that they're looking over a longer period, these discussions are still going on, but it could be over a number of years."

Dutch bank ING voluntarily breaks apart

"PARIS — ING Group, the Dutch financial services company, said Monday that it planned to break up its insurance and banking businesses and raise up to 7.5 billion euros, or $11.3 billion, in a stock issue, after reaching a deal with the government to repay ahead of schedule half the money it received in a bailout last year.

ING was propped up with 10 billion euros in emergency funds from the Dutch government in October 2008, which helped cushion the company’s core Tier One capital, a measure of financial strength, during the global financial crisis. Since then, the company has begun divesting itself of assets in Europe, Asia and North America in an attempt to raise capital and restructure, as well as appease European Union regulators, who are still investigating the Dutch government’s aid to ING under an asset guarantee program the two entered in January.

The group said Monday that it had wrapped up talks with European Union officials that had led to its decision to separate its banking and insurance businesses, seeking to divest the latter over the next four years.

“Negotiations with the European Commission on the restructuring plan have acted as a catalyst to accelerate the strategic decision to completely separate banking and insurance operations,” the company said. “ING will explore all options, including initial public offerings, sales or combinations thereof.”

Jan Hommen, chief executive of ING, said in a statement that “splitting the company is not a decision we took lightly,” as the combination of banking and insurance provided the company with advantages of scale, capital efficiency and earnings from a diversified portfolio of businesses, but he said those benefits had been diminished by the financial crisis.

The company will seek formal approval for the restructuring plan at an extraordinary general meeting of shareholders next month. In keeping with its new direction, the company said it would restructure its management board.

As part of the deal with the European Commission, ING agreed to sell its U.S. Internet banking arm, ING Direct, by 2013. The company anticipates that it will take several years to get out of the business, but said that it regards the operation as “a very strong franchise” and the U.S. market offers potential for growth.

Those divestments, as well as others, will result in a company with about a third less assets by the end of 2013 than it had when the financial crisis struck last autumn, with its balance sheet expected to be reduced by 600 billion euros, the bank said.

All European banks that received state aid during the financial crisis had to submit restructuring plans to the European Union.

Under the new agreement with the Dutch state, ING has until the end of January next year to repurchase shares issued as part of the bailout, which it plans to do using proceeds from the new stock issue, which will be put up for shareholder approval on Nov. 25.

The early repayment allows ING to pay a 15 percent premium on the securities, or up to 950 million euros, rather than a premium of 50 percent under the original terms of the deal, which would have come closer to 2.5 billion euros.

“We appreciate the ongoing support of the Dutch state,” Mr. Hommen said, “but fully recognize that it is in the best interest of all parties that we get back on our own feet as quickly as possible.”

During a conference call, he said the group would likely pay back the rest of the bailout money before the end of 2011.

Further divestments, Mr. Hommen said, as well as profit from operations, would help ING repay the remaining funds it owed.

The company has been shedding assets steadily this year. It said this month that it had agreed to sell its Swiss private banking unit to the wealth manager Julius Baer. It also announced the sale of part of its North American reinsurance operations to Reinsurance Group of America, the American insurer. And in Asia, Oversea-Chinese Banking Corp. of Singapore agreed to buy ING’s private banking assets in the region for nearly $1.5 billion.

ING said in a separate statement on Monday that it expected net profit for the third quarter, from both banking and insurance operations, would come to 750 million euros after divestments and special items.

A 1.3 billion euro charge that ING took for a payment under the government’s asset guarantee program backing about 22 billion euros in risky mortgages will be booked in the fourth quarter, the company said.

ING shares were down 0.63 percent, or 11 cents, to 17.37 euros in late morning trading in Amsterdam."

European Commission action on TBTF

"Neelie Kroes has, according to one analyst in London, “cut through all the bullshit”. Europe’s competition commissioner has trod where national regulators dare not, by imposing harsh penalties on the banks that received the biggest bail-outs in Europe. On November 3rd Britain’s two monsters, Royal Bank of Scotland (RBS) and Lloyds Banking Group (LBG), got the treatment. In the preceding week ING, a Dutch insurance and banking conglomerate, surprised investors by announcing a break-up and a capital raising. Over the summer Germany’s Commerzbank and WestLB both agreed to tough penalties. Several more banks, including Dexia and KBC, both based in Belgium, and Germany’s Hypo Real Estate, are next in the commission’s line of fire.

Ms Kroes is acting under a generous interpretation of her mandate. The objectives of reversing the damaging effects of state aid on competition and of ensuring that bailed-out firms have viable business plans are not controversial. But the commission’s apparent desire to address concerns over moral hazard by punishing firms that have been rescued by the state is much more provocative. National governments have so far done precious little to tackle this issue. That partly reflects their defence of national champions, but also a reluctance to start messing about with big banks while the supply of credit to the economy is still under threat and while they still need to raise more equity from private investors.

The two big German restructurings were arguably the most straightforward. Both Commerzbank and WestLB will shrink their balance-sheets by about half from their peak (see chart). It was relatively simple to identify those bits of the banks that were sick, such as property, or sub-scale, such as international operations.

ING will shrink dramatically, too. About half of the reduction in its balance-sheet will come from offloading its insurance operations. It is hard to see how this improves either competition or the firm’s viability, but it does at least chime with the views of many investors that ING’s conglomerate model is too unwieldy.

The other zombies are harder to deal with, as the British examples show. The disposals being forced on RBS owe little to competition or viability concerns and quite a bit to the punishment motive. RBS will offload peripheral operations—such as insurance and its commodities unit—that make money, are healthy, and which it might otherwise have sensibly retained.

LBG, meanwhile, has few peripheral assets (aside from an insurance business which it was miraculously allowed to keep). It has got off much more lightly than the other banks, and though this may reflect pressure from the British government, it also reflects genuine economic concerns. Breaking up LBG’s bog-standard British lending activities would be disruptive for customers in the short term, and forcing it to cut its dangerous reliance on wholesale funding too quickly would starve house-mad Britons of mortgage credit.

KBC also presents problems. Its insurance operation is much more closely integrated into its branch network than those of ING or RBS, and forcing it to sell its central and eastern European operations would run against wider political objectives. It may shrink by less than others as a result. Likewise the commission has sounded tough on Dexia, a Franco-Belgian lender, demanding that it come up with a plan early next year. But although its business model now seems barmy—a partly state-owned bank that raises government-backed funds to lend to local governments—it performs a vital economic function that cannot be replaced easily. Ireland’s banks are in a mess too, but the government’s bail-out package has yet to be finalised and any European sanctions are some way off.

In short, the high point of European Commission intervention has probably been reached. That leaves much in the hands of Europe’s national governments and although there are good reasons to doubt their resolve, there are no grounds at all to understate the task at hand.

The capital positions of Europe’s banks look passable but most of the existential questions about banking are arguably harder to solve for Europe than for America. America has Bank of America, JPMorgan Chase and, perhaps, Citigroup to worry about as firms that combine “casino” investment-banking arms with “utility” retail and commercial lending. Europe has at least seven comparable firms: Deutsche Bank, Barclays, RBS, BNP Paribas, Société Générale, Credit Suisse and UBS, the last of which reported the latest in a string of weak results on November 3rd.

The mismatch between its internationalised banks and national fiscal authorities also makes things more complex for Europe. Josef Ackermann, the boss of Deutsche Bank, warned on November 2nd that organising banks into stand-alone national silos would “effectively kill” the single banking market in Europe. Some countries in Europe—such as Switzerland, Britain and Ireland—are home to banks that are so big they may exceed the capacity of their economies to save them.

Finally, European banks have a bigger wholesale-funding problem than American ones, with explicit central-bank and government-guaranteed debt of $2 trillion outstanding in the middle of this year, about triple American levels. Funding is the industry’s secret subsidy: without explicit or implicit guarantees many banks would teeter. Yet it is also the hardest issue of all to grapple with, not least because there is no easy way to replace it without shrinking banks’ balance-sheets in a manner that damages the supply of credit. Whatever it is that Neelie Kroes has cut through, there is a lot of it left.

UK efforts to reduce bank size

Her Majesty's Treasury on Lloyds and RBS

The Government is today announcing the conclusion of discussions with Lloyds Banking Group (Lloyds) and Royal Bank of Scotland (RBS) regarding their participation in the Government’s Asset Protection Scheme (APS).

As a result of improved market conditions and following extensive due diligence announced in February, the Government can today announce that:

  • Lloyds will not participate in the APS and instead will raise additional private sector capital and pay a fee to the taxpayer for the implicit protection provided to date. This will reduce the risk borne by the taxpayer, improving value for money;
  • RBS will participate in the APS under revised terms that improve incentives and deliver better risk-sharing with the private sector.

The likely costs to the taxpayer and the risks on the impact on the public finances have been reduced. Both banks will still be required to meet tough conditions on pay and lending set out below.

To promote greater competition in UK banking, and meet EU State Aid rules, the banks will also be required to make divestments of significant parts of their businesses over the next four years.


The APS was announced in January to remove uncertainty about the value of banks’ past investments and allow banks to rebuild and restructure their operations to increase lending in the economy. All major UK banks were eligible to apply.

At the time the world’s financial system was facing a worsening crisis of confidence about the underlying value of bank assets. This was undermining financial stability and preventing the UK banking system from providing loans and mortgages.

In-Principle Agreements with Lloyds and RBS

RBS and Lloyds agreed in principle in February and March respectively to participate in the APS and in return to pay a fee to the taxpayer. They also entered into legally binding commitments to increase lending in the economy.

At the time the APS was announced, both RBS and Lloyds had insufficient capital to withstand the downside risks to their balance sheets. They were unable to raise this capital through the private sector, and needed to call on the capital protection afforded by the APS.

These agreements have given both banks implicit protection for their balance sheets, allowing them to begin the process of rebuilding and restructuring the healthier core of their businesses and to increase lending.

As announced at the time, final agreements with both banks would be subject to:

  • HM Treasury undertaking a thorough due diligence of the assets that RBS and Lloyds proposed to put into the APS;
  • Ensuring the terms were consistent with EU State aid requirements;
  • Rigorous stress-testing on both banks by the FSA, in line with the stress-testing framework it announced in May.

Together, these steps have given greater clarity about the scale and timing of likely losses and the impact those could have on Lloyds and RBS.

Following the completion of negotiations with the banks, the Government is now reporting to Parliament at the earliest opportunity the revised terms of agreement with RBS, and its decision with respect to Lloyds’ exit from the scheme.

Improved market conditions

Since the APS was announced, market conditions have improved markedly – largely as a result of the action the Government has taken, both domestically and globally in coordination with our partners in the G20 and European Union.

The announcement of the APS has helped to restore confidence in the banking system and banks are now able to secure capital support from the private sector in a way that was not possible six months ago.

Lloyds Banking Group

Under the March APS agreement with Lloyds, the Government would have been called on to cover 90% of losses for the £260 billion in assets covered under the scheme after the first loss had been exceeded. Today’s agreement removes this significant contingent liability to the taxpayer.

As a result of the confidence provided by the APS, and improved market conditions, Lloyds can now raise sufficient capital through the market to meet the FSA’s capital requirements without the need for additional support from the APS.

Lloyds has announced plans to raise £21bn through a combination of a £13.5bn rights issue, and £7.5bn by swapping existing debt for contingent capital. This option represents better value for money for taxpayers, as the private sector will now provide the majority of the capital required to protect Lloyds from the downside risks to its balance sheet.

Lloyds will also pay the Government a fee of £2.5bn in return for the implicit protection already provided by the taxpayer since the announcement earlier in the year. The Government will take up its rights as a shareholder in Lloyds to participate in the planned capital raising, investing £5.7bn net of an underwriting fee.

This will see the Government’s shareholding in Lloyds remain at 43% and therefore maintain the return for the taxpayer when the Government’s shares are eventually sold.


The Government’s final agreement with RBS on its participation in the APS reflects the due diligence it has undertaken, FSA stress tests and the requirements of the European Commission’s State Aid guidelines. All material commercial issues have now been agreed with RBS. Full legal documents are being finalised and will be signed shortly. These arrangements remain subject to final approvals, including by the European Commission.

The final agreement involves:

  • A larger first loss to RBS than agreed in February – the first loss to be borne by RBS has increased from £42bn to £60bn;
  • A smaller pool of insured assets – reduced from £325bn to £282bn based on their balance sheet at end 2008;
  • A capital injection by the Government of £25.5bn –– equal to the £25.5bn total capital commitment announced in February, which comprised £13bn in upfront capital, £6bn of capital to be drawn at the option of RBS and £6.5bn in a fee taken as capital;
  • A fee to the Government to be paid annually at £0.7bn for the first three years, followed by £0.5bn a year for the life of the scheme – compared to the up-front fee of £6.5bn paid in shares agreed in February;
  • Removing the undertaking, agreed by RBS in February, to forego for up to five years certain tax losses and allowances. This was estimated at a value of £9-11bn in RBS’ most recent accounts.

As a result the Government’s economic interest in RBS will rise to 84%, consistent with the agreement in February, but the Government’s ordinary shareholding will not exceed 75%.

To reflect the £18 billion increase in the first-loss borne by the company, the Government will no longer require RBS to give up its tax losses and allowances. And to protect against a worst-case scenario the Government will provide a contingent capital commitment of up to £8 billion. This would be drawn down in two tranches and only in exceptional circumstances where RBS’s Core Tier 1 capital ratio fell below 5%. In return RBS will pay a fee of 4% a year for the contingent capital. The FSA has confirmed that, with these measures, RBS complies with its stress testing framework.

The Government has also agreed that RBS will pay a minimum exit fee when it leaves the APS. The minimum fee will be the largest of either:

  • £2.5bn, or
  • 10% of the actual regulatory capital relief received by RBS while it was in the APS

This fee will be less any fees already paid. Exit would need to be approved by the FSA.

Additional Commitments by the Banks

The Government’s priority in its negotiations with both banks has been to support financial stability, provide value for money for the taxpayer and ensure that the benefits of healthier banks translate into increased lending in the economy.

In return for taxpayer support provided, both banks have agreed:

  • That existing commitments to increase lending to businesses and homeowners by a total of £39bn for both banks will remain in place;
  • A commitment to ensure charging for current accounts and overdrafts is transparent and fair and that customers are not overcharged;
  • A ‘Customer Charter’ for lending to small and medium enterprises to reinforce their commitment to meeting all reasonable applications for finance from viable businesses;
  • Not to pay discretionary cash bonuses in relation to 2009 performance to any staff earning above £39,000;
  • In addition executive members of both boards have agreed to defer all bonuses payments due for 2009 until 2012, to ensure that their remuneration is better aligned with the long-term performance of their banks;

These build on their existing commitments to implement the G20 remuneration principles, the FSA Remuneration Code and any relevant provisions accepted by the Government from the Walker Review.

Competition Requirements

The Government has reached agreement in principle with Commissioner Kroes after constructive and helpful discussions on a package of restructuring and other measures, which we are confident will address the concerns of the European Commission. The package is now subject to agreement by the College of Commissioners.

To promote greater competition in the UK banking sector, and as part of the State aid requirements of the European Commission, the Government has agreed restructuring plans for RBS and Lloyds that include the divestment of a significant proportion of their retail and corporate banking assets over the next four years.

To ensure these divestments increase diversity and competition in the UK banking market, the assets can only be sold to small or new players in the market. The divestments from each bank will represent a viable stand-alone entity, together representing nearly 10% of the UK retail banking market.

Reduced risks to the taxpayer

As a result of all of these factors, the likely costs to the taxpayer and the risks on the impact on the public finances have been markedly reduced:

  • The total contingent liabilities the public finances are exposed to have reduced by over £300bn as a result of Lloyds not participating and RBS reducing the value of assets covered by the scheme.
  • The remaining risks are better shared with private sector shareholders – for Lloyds, the private sector will provide £15bn of capital and for RBS, the first loss on the remaining £282bn of contingent liabilities has increased to £60bn.
  • The Government estimated in the Budget that the impact of the financial sector interventions would be between £20-50bn and prudently included £50bn in the public finance projections. We expect, subject to wider factors, to revise these figures downwards in the Pre-Budget report, alongside the Government's fiscal and economic forecasts.

However, the purchase of shares would, all other factors being held constant, increase the central government net cash requirement (CGNCR) for 2009-10 by around £13 billion relative to that announced at Budget 2009. The CGNCR for 2009/10 will be updated in the Pre-Budget Report, to account for all changes since the Budget including, for example, the net receipt from the redemption of Lloyds preference shares in June 2009.

Next steps and Timetable for Reporting

The Government has reached agreement on the substantive elements of the deals with both Lloyds and RBS and is now announcing these at the earliest possible opportunity.

Full legal documentation on RBS’ participation in the APS is being finalised following this agreement and will be published shortly. Lloyds has signed an exit agreement and this has been provided to Parliament separately today.

Following European Commission approval, which we expect over the next few weeks, the Government will publish:

  • Comprehensive details of the agreements
  • Detailed scheme rules
  • Further information on the assets

In the future, the Government will continue to report to Parliament on the APS by:

  • Reporting to Parliament in the Budget and PBR
  • Publication of audited annual accounts by HM Treasury and the Asset Protection Agency (APA) on the performance of assets in the scheme
  • Auditing of the APA by the NAO

UK Chancellor on bank restructuring

Check against delivery

Mr Speaker, with permission, I would like to make a statement on the banks in which we have shareholdings.

This morning, the Treasury, Lloyds and RBS issued market notices in the usual way.

Mr Speaker, in October last year, I set out a range of measures designed to prevent the collapse of the banking sector.

Those measures are working, and countries across the world took very similar steps over the following few weeks.

But the uncertainty in global financial markets had a very serious impact on confidence, resulting in a world recession.

This, in turn, worsened the outlook for our economy, leading to higher losses for UK banks.

It was clear further action was needed to strengthen the banks – and in January we announced an Asset Protection Scheme, to prevent a further shock to confidence and ensure lending could continue.

We continued to support the economy through fiscal and monetary policy, and co-ordinated a global policy response at the London Summit in April.

Those measures are working too – fears of a global depression have receded and market confidence has started to return.

As a result we are now able to achieve our objectives on financial stability and banking reform at a lower overall cost to the taxpayer.

Mr Speaker, the Asset Protection Scheme I announced in January has played a vital role in supporting confidence in financial markets.

Let me remind the House of the key features which I set out then.

It provided insurance against losses arising on a pool of bank assets, and in return the banks paid a fee in the form of shares.

The effect of the scheme is to strengthen the capital position of any bank in the Scheme – but, of course, this carries a risk of exposure for the taxpayer.

The Scheme was open to all major UK banks.

In the event, improved market conditions meant that only two banks decided to participate.

Since then, further improvement in market conditions means Lloyds have been able to develop a better plan.

They now don’t need to participate in the Scheme – and this will significantly reduce the cost and exposure for the taxpayer.

Mr Speaker, I will now explain in detail our proposals to better restructure the banks and make them stronger.

Turning first to Lloyds.

Following the recapitalisation last October, the Government owned 43 per cent of the bank.

In March, we reached an agreement in principle with Lloyds on their participation in the Scheme.

This would have increased, through the fee, their capital by over £15bn, increasing the cost to Government and increasing our stake in Lloyds to 62 per cent.

And we agreed then in principle to insure £260bn of assets, giving us a very large contingent liability.

But now that market conditions have improved, we’ve agreed a better proposal for Lloyds, to bring in substantial private capital and reduce taxpayer exposure.

So Lloyds have announced today they will raise £21bn in the open market.

This capital raising is fully underwritten by commercial banks.

As a shareholder, the Government has the option to take-up part of the newly-issued equity.

If we did not do so, the value of the existing taxpayer shareholding would be diminished.

So to protect the value of our shares, we have decided to take-up our share of this new capital, investing £5.7bn net of an underwriting fee.

By raising capital in the markets, Lloyds will begin its transition from state support to private finance, and no longer need the insurance of the Asset Protection Scheme.

Because Lloyds have benefited from the existence of the Scheme since March, they have agreed to pay the Treasury a fee of £2.5bn and to reimburse our costs.

Mr Speaker, today’s decisions make Lloyds a stronger bank and provide better value for the taxpayer:

  • Ending exposure through the insurance scheme;
  • With a substantial fee in return for the insurance provided to date;
  • And a substantial capital contribution from the private sector, while maintaining our shareholding at 43 per cent;

Mr Speaker, I now turn to the Royal Bank of Scotland.

It is a bigger bank than Lloyds, with a more complex balance sheet, and greater exposure to losses, mainly due to their purchase of the Dutch investment bank ABN Amro.

Under February’s agreement in principle, the Government would insure £325bn of assets through the Asset Protection Scheme, as well as providing:

  • An additional capital injection of £13bn;
  • A second tranche of capital amounting to £6bn;
  • And a further £6.5bn worth of capital support through additional shares issued to pay the fee.

Together, this would have increased RBS's capital by £25.5bn, taking the Government stake to 84 per cent.

Mr Speaker, before we could reach a binding agreement, we needed to:

Carry out due diligence on the assets;

And ensure the final terms were consistent with emerging European Commission guidelines.

The restructuring guidelines were published in July, following extensive work with the UK and other countries.

We and the FSA have now also completed due diligence work on the RBS balance sheet.

As a result, we are making a number of changes to the terms of the scheme, which will improve incentives and better share risks with the private sector.

Mr Speaker, while market conditions have improved, RBS still needs to do more to be able to stand on its own feet.

So we will continue with our plan to invest £25.5bn of capital into RBS.

But there are three key changes.

First, there will be a £43bn reduction in the pool of assets covered by the insurance scheme – reducing the Government’s contingent liability.

Second, the first loss on these assets – payable by RBS – will be increased from £42bn to £60bn – further protecting the taxpayer.

Third, in return, RBS will pay an annual fee of £700m for the next three years and £500m per year thereafter, giving them an incentive to leave the scheme as conditions improve.

And when they do leave the APS, they must have paid a minimum fee of £2.5bn or 10 per cent of the actual capital relief received.

To reflect the increase in the first loss, amounting to £18bn more payable by RBS, we will no longer require RBS to give up its tax losses, which they estimate at between £9-11bn.

And in the unlikely event of a severe downturn, it may be necessary to provide up to £8bn contingent capital.

But this will only be triggered if there is severe stress, taking their core capital ratio to below 5 per cent.

Again, in return for this, RBS will pay an annual fee of £320m for as long as the contingent capital is available.

Mr Speaker, in the case of RBS, the overall level of Government support will remain broadly the same as announced in February.

But this revised deal is better structured, with better risk sharing and greater incentives to exit:

  • There is a higher first loss payable by RBS - £60bn up from £42bn;
  • Better incentives, with a fee of £700m for 3 years and £500m thereafter;
  • And fewer assets to be insured - £282bn instead of £325bn.

And I will provide the House with full details of the operation of the scheme when the final agreement is signed and approved by the Commission.

Mr Speaker, as part of these restructured deals, we are pushing forward with reform at these banks – with improved lending and remuneration policies.

Both Lloyds and RBS will be in a stronger position to continue lending.

Lloyds will increase lending capacity this year and next – with an additional £11bn for businesses and £3bn for homebuyers in each year.

RBS will continue to meet their lending commitments of £25bn this year and next.

And both will publish customer charters on good practice on SME lending – increasing transparency and improving loan conditions for business customers.

Mr Speaker, on pay, all major retail and investment banks in the UK need to meet the G20 principles and FSA rules, so that bonuses have to be:

  • Transparent, variable, and with no multi-year guarantees;
  • Between 40 and 60 per cent deferred over a number of years, not paid immediately;
  • Subject to claw-back, to ensure pay is aligned with long-term performance;

But we have agreed with RBS and Lloyds that they will go further than this. For this year, there will be no discretionary cash bonuses, except for staff earning less than £39,000 a year.

And, in addition, the executive boards of both banks will have their bonuses deferred in full until 2012.

This goes much further than the G20 agreement and further than any other banks in the world.

Mr Speaker, I will continue to strengthen the supervisory regime, building on my proposals in July, by:

  • Adopting the recommendations of the Walker review on corporate governance for banks;
  • Reforming the mortgage markets;
  • And legislating to make banks put in place “living wills”, as well as enhanced powers and objectives for the FSA, to further strengthen regulation.

Mr Speaker, I believe these steps are better for the taxpayer, better for the banks and better for the economy.

As a result, the likely cost to the taxpayer and the risks faced by the public finances have reduced markedly.

The total assets protected have reduced by over £300bn, there is more private sector investment, and the fees received are better structured.

And I expect, subject to wider factors, to revise downwards the provision for financial sector interventions at the Pre-Budget Report.

Mr Speaker, as I said in my statement in July, our second objective is to encourage greater banking competition, in the high street and for small and medium businesses.

Since the financial turmoil started in 2007, the banking industry has become more concentrated in most advanced economies.

But over the course of this year, we have been working with the Commission to agree on how to restructure the banks while meeting State Aid rules.

For Northern Rock, I have already set out my intention to split the bank into two separate companies – and we now have Commission approval for this.

This will mean less capital support is needed to keep Northern Rock lending – and when the time is right, it will facilitate a return to the private sector.

Lloyds will sell Cheltenham and Gloucester, the Intelligent Finance internet bank, the TSB brand, Lloyds TSB Scotland, and some Lloyds TSB branches in England and Wales.

Altogether over 600 branches by 2013.

RBS plan to sell their insurance businesses – including Direct Line and Churchill – as well as its commodity trading arm and its card payment processing operation.

It will also divest over 300 branches across the UK by 2013.

Together, these businesses could potentially amount to about 10 per cent of the retail banking market in the UK.

And, Mr Speaker, in each and every case, we will insist these institutions should not be sold to any of the existing big players in the UK banking industry.

So Lloyds and RBS will each be required to sell their retail and SME businesses, as a single viable package, to a smaller competitor or new entrant to the market.

And this, together with Northern Rock, will potentially create three new banks on our high-street in the space of five years.

This will increase diversity and competition in the banking sector – giving customers more choice and better service.

Mr Speaker, the financial services sector will remain an important part of our economy.

Yesterday’s job losses, announced by RBS, are a reminder that for many employees these are very difficult times.

We will do everything we can to work with the banks to help find new jobs for those affected.

Mr Speaker, I believe my proposals today will ensure we have a strong and vibrant financial services sector in the future.

They will mean stronger and safer banks better able to support the recovery.

And more competition and more choice for the people who use them.

And I commend this statement to the House.

UK bank regulators move swiftly

"Royal Bank of Scotland Group Plc and Lloyds Banking Group Plc will receive 31.3 billion pounds ($51 billion) in a second bailout from the U.K. taxpayer as the two banks agreed to cap bonuses.

The Treasury will inject 25.5 billion pounds of capital into RBS, for a total of 45.5 billion pounds, making it the costliest bailout of any bank worldwide. The government will fund about a quarter of Lloyds’s 21 billion-pound fundraising. Both banks said they won’t pay cash bonuses to workers earning more than 39,000 pounds this year.

The rescue will bring the government closer to full ownership over RBS, while Lloyds will escape government control. Lloyds CEO Eric Daniels will raise funds from money managers to avoid the Treasury’s asset insurance plan that would give the government a majority stake. He’s betting bad loans will decline after the Bank of England said the country’s recession was nearly over. In contrast, Stephen Hester, RBS’s CEO, will accept greater government oversight and insure 282 billion pounds of his banks’ riskiest assets with the Treasury.

“There is now a very fine line between RBS being nationalized,” said Danny Gabay, director of Fathom Consulting in London and a former Bank of England economist. “This contrasts with Lloyds willing to fight harder for its independence.”

RBS fell as much as 12 percent and traded down 11.5 percent at 34.21 pence as of 3 p.m. in London trading, for a market value of 19.3 billion pounds. Lloyds climbed 1.5 percent to 86.25 pence.

‘Still Unattractive’

“From an investors’ point of view RBS and Lloyds are still unattractive because the government’s stake is so high,” said Richard Hunter, London-based head of U.K. equities at Hargreaves Lansdown Stockbrokers. “This is a vindication of Barclays and HSBC decision to do everything possible to remain outside the shackles of government intervention.”

Today’s bailout for RBS and Lloyds follows the 37 billion pounds the two lenders received last year and will bring the government’s stake in RBS to more than 84 percent from 70 percent today.

Lloyds, the U.K.’s biggest mortgage lender, plans to raise 13.5 billion pounds in the U.K.’s biggest rights offering, and 7.5 billion pounds in exchange offers, the London-based bank said in its statement. The U.K. will keep its stake in Lloyds at 43 percent by taking up its rights to buy 5.8 billion pounds of stock in the sale.

Directors of both banks will defer their 2009 bonus payments until 2012, the Treasury said today.

‘Bear Down on Remuneration’

“We don’t want to demonize people in banking,” City Minister Paul Myners said in an interview with BBC television today, adding that most people in banking are not highly paid. “But at the top of banking, we’re going to bear down on remuneration.”

“We will be extensively using deferral mechanisms and using shares as part of over bonus delivery this year and indeed not paying cash, as was the case last year,” RBS’s Hester said in a conference call with journalists today. However, the surest way for the taxpayer never to see value for its support is if RBS is unable to have good people.”

The government will buy 25.5 billion pounds of “B” shares in RBS to strengthen the lender’s capital, the bank said in a statement today. The government may buy an additional 8 billion pounds of the shares if RBS’s core Tier 1 capital ratio falls below 5 percent. The bank said it doesn’t expect to require the extra 8 billion pounds.

The lender will also sell its insurance division and some bank branches after negotiations with the European Commission and the U.K. Treasury.

‘Smell of Politics’

“It all smells to me a bit of politics and the start of election campaigning,” said Lothar Mentel, chief investment officer at Octopus Investments Ltd., which oversees $2 billion, including a stake in Lloyds. “The government wants to be seen as punishing the banks, whereas addressing the underlying problems of credit derivatives is a lot more complicated and less headline grabbing.”

Lloyds’s fundraising will boost its core Tier 1 capital to 8.6 percent from 6.3 percent. The bank will sell a retail banking unit with a 4.6 percent share of the U.K. current account market and 19 percent of the group’s mortgage balances to gain EU approval for its bailout last year.

Cheltenham & Gloucester

The bank will also sell Cheltenham & Gloucester-branded accounts and mortgages, its Intelligent Finance online unit, some Lloyds TSB branches and the TSB brand within four years, the bank said.

Under RBS’ revised terms of the asset protection plan, the bank will be responsible for the first 60 billion pounds of losses on the risky loans it puts into the program, compared with the 42.2 billion pounds initially agreed. It will be able to exit the program at any time in return for a 2.5 billion- pound payment, as long as the first loss hasn’t been exceeded.

The bank also agreed to sell its RBS branches in England and Wales, NatWest branches in Scotland, the Global Merchant Services unit and its stake in its Sempra commodities trading division. The bank said it may also hold an initial public offering of its insurance divisions.

The units generated 5.75 billion pounds of revenue last year, RBS said today. That’s about 21 percent of 2008’s total, according to RBS’s preliminary results reported in February.

RBS’s Hester is unwinding acquisitions made by his predecessor Fred Goodwin who helped lead the bank during $140 billion of takeovers, swelling the balance to 2.2 trillion pounds, exceeding Britain’s annual economic output.

RBS said today it was forced to dispose of 318 branches in the U.K., which is about 14 percent of the bank’s branches. This will reduce the bank’s U.K. market share by 2 percent in retail banking, 5 percent in SME banking and the mid-corporate market.

Lloyds said it will shed 600 branches, reduce the bank’s mortgage assets by 19 percent and its share of current accounts by 4.6 percent."

High Street banks to be broken up

Chancellor Alistair Darling has confirmed that Lloyds, RBS and Northern Rock will be broken up and parts sold to new entrants to the banking sector.

He said there could be three new High Street banks in the UK over the next three to four years as a result.

But the chancellor said he would only sell parts of the banks when "the time is right", to ensure taxpayers get their money back.

There is speculation that buyers might include Tesco and Virgin.

'Clean sheet'

In order to boost competition, the banks' assets will only be sold to new entrants to the UK banking market and not to existing financial institutions.

The new banks will be standard retail operations concentrating on deposits and mortgages.

Mr Darling said this was the best way to ensure "proper competition and choice". He said having just "half a dozen big providers was not acceptable".

The new entrants would "have a clean sheet to come in and do things differently", he added.

The chancellor also said the government would be splitting up Northern Rock into two parts by the end of the year, with a view to selling off one part within the next three to four years.

The government had already said it wants to sell off the part of Northern Rock that holds savers' money, carries out new lending and holds some existing mortgages.

He also said the government was keen to divest some of its holdings in RBS and Lloyds. The government currently holds a 70% stake in RBS and a 43% stake in Lloyds after last October's bail-outs.

'Unnecessary distraction'

BBC business correspondent Joe Lynam says the latest move represents "a gilt-edged opportunity for non-UK retail banks, especially from the US, to get a firm foothold in the highly profitable British banking market for as low a price as could be imagined a few years ago". The Conservatives said the break up of the state-owned banks had already been "well trailed". A spokesman added: "We have called for more competition in banking, and for government stakes to be used to strategic effect to that end."

The Lib Dems Treasury spokesman Vince Cable welcomed more competition in the banking sector but said there should be no urgency to the sales.

"We need to be careful that when these split-ups occur, the prime cuts are not offered to private investors and the scraps left to taxpayers," he said.

There were also concerns expressed about the timing of the sell-off.

Treasury select committee chairman John McFall MP said the assets should not be sold off for less than their market value.

"It is important to ensure that we get taxpayer return for this bail-out. I'm relaxed about the timescale. I do not want to sell off [bank assets] at a cheap price, I don't want a fire sale," he told the BBC.

Peter McNamara, former head of personal banking at Lloyds TSB and managing director of the Alliance and Leicester, said that restructuring the banks in the current climate could in fact prove counter productive.

"Half the banks in the UK are suddenly going to be reorganised when you could argue their day job is to support industry and consumers during the recession. Without that support, we are more likely to have a steeper rise in unemployment," he said.

The government needs permission to break-up the banks from European competition commissioner Neelie Kroes.

Last week, the EU approved the plans for Northern Rock to be split in two.

FSA and ringfencing Citi assets

Buried in the Congressional Oversight Panel’s 127-page November report, examining the ‘moral hazard’ involved in the US Government’s guarantees for financial institutions, is this tidbit:

(Footnote 193) Treasury conversations with Panel staff (Oct. 19, 2009); Federal Deposit Insurance Corporation, Responses to Panel Questions About the AGP (Oct. 30, 2009) (in its responses, the FDIC noted that “[o]n Friday, November 21, 2008, market acceptance of the firm’s liabilities diminished, as the company’s stock plunged to a 16- year low, credit default swap spreads widened by 75 basis points to 512.5 basis points, multiple counterparties advised that they would require greater collateralization on any transactions with the firm, and the UK FSA imposed a $6.4 billion cash lockup requirement to protect the interests of the UK broker dealer….”)

That would have been a blow for the beleaguered bank. At the end of October 2008, Citi had something like $63bn of cash (and “due from banks”) on its books. But presumably the FSA would have been trying to prevent a repeat of the Lehman collapse, when the London office of the investment bank suddenly found itself without cash — the New York office having transferred $8bn back to the States on the day the firm declared bankruptcy.

And yet according to the report, Citi wasn’t necessarily fearing for its existence in the last weeks of November, when Lehman’s fall was still rocking financial institutions and Citi’s shares had dropped a precipitous 72 per cent over the course of the month. Instead the bank was worried about what the market thought of its prospects for survival:

(Footnote 192) Citigroup conversations with Panel staff (Oct. 26, 2009). It is interesting to note that in discussions with Panel staff, Citigroup personnel, perhaps naturally, emphasized external elements such as market perception and share price, while government officials focused on whether Citigroup could open its doors the following Monday.

In any case, the government did eventually step in — announcing a $20bn Tarp injection for the bank, plus an Asset Guarantee Program, which saw the Treasury, FDIC and the Federal Reserve agreeing to share losses on $306bn of Citi’s assets.

And those concerned that Citi simply shoved its most toxic assets into the guarantee programme — thus transferring the burden of the losses to the US taxpayer — needn’t worry.

According to Citi’s comments to the COP staff, it only shoved what the market thought were its riskiest assets:

Citigroup stated during a conversation with Panel staff that in determining the assets to be guaranteed, it included mainly “high headline exposure” categories of assets, not necessarily the technically riskiest, but the types of assets that the markets were most worried about and the guarantee of which would attract the most market attention. Citigroup also stated that it included in its initial proposal all of the assets in each of these categories in an effort to demonstrate it was not “cherry-picking” assets and to reflect moral hazard concerns. Citigroup conversations with Panel staff, October 26, 2009.

We’re sensing a Cartesian theme here.

Much more — including detail on Bank of America’s almost-participation in the AGP, plus the money market funds’ guarantee — in the full report.


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